Are Stop-Loss Orders Still Safe?

If you own shares in one of the 3 stocks that rapidly lost value last week (3M, Proctor and Gamble, and Accenture), then you might be wondering whether or not a stop order (or stop-loss) is a good idea. In case you don’t know, a stop-loss is a standing order you place to sell a stock next tick once the position reaches a certain price. You would do this in order to protect yourself against a loss that you don’t want to bear.

For instance, let’s say you buy 100 shares of ABC at $100 per share. You decide that you want to sell once the stock reaches $85 because you do not wish to lose more than 15% of your investment. So you tell your broker to enter a standing stop order (or good until canceled) to sell next tick once the price hits $85.00. This allows you to tear your eyes away from the stock tickers each day and not obsessively watch over your investment because you know the system will execute your order for you.

But last week, a whole lot of stop-loss orders for MMM, PG and ACN were probably executed as these positions seemed to enter a free fall on May 6th. Since this loss was based on an error of an as yet undetermined nature, it may make some investors wonder if it isn’t a bad idea to have stop-loss orders in the system. After all—do you really want your stock sold because of an error that corrects itself within the same day?

Personally, I would not worry about it. What? After a crisis like last week’s I dare to be so calm and casual about the situation? Yes, yes I do dare. Why? Well, first of all we don’t exactly know yet what caused the error. Some people seem to think that a trader accidentally entered a B instead of an M into the trading system resulting in billions of PG shares being sold instead of millions. Now, I can’t say that I’ve touched every trading system out there, but the one that I did use did not utilize any letters to enter trades and also had safeguards when large volumes were entered. In fact, we had to give verbal confirmation for certain trade volumes—and we were not doing large institutional trades, we were simply trading accounts with values ranging from $1,000 to $10,000,000. And because some stocks (like Berkshire Hathaway) have such a large value per share, we had to give verbal confirmation for trades of certain dollar amounts—regardless of number of shares. Because of this experience, I find it hard to believe that an even more sophisticated and high-level trading system would not have similar safeguards.

Back to your stop-loss. I’m of the mind that the mistake was system-oriented and a one-off issue. Maybe buy orders were not being processed while sell orders were. Maybe the algorithmic trading systems went wrong somewhere. Either way, it is not something that you see often (after all, when was the last time this happened?) and it is probably not something that you’ll see happen again. A significant—and real—loss in your stock values based on fluctuating consumer confidence is something you could see however, and is why a stop-loss order is still a great idea.

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Author Info

This post was written by Yolander Prinzel. Yolander is a financial writer as well as a series 7, 66 and 2-15 licensed representative. During her decade of financial industry experience she has been an insurance agency director of marketing and director of operations, a life insurance underwriter, and a trading service specialist for Raymond James Financial Services. She was a featured speaker at the 2006 Hartford National Sales Conference and the 2006 Brookstreet Securities Annual Conference. Check out her portfolio at YolanderPrinzel.com

5 Responses to “Are Stop-Loss Orders Still Safe?”

  1. Sun |  May 14, 2010 at 9:56 am

    Maybe not in this particular case, but it’s still a valid tool for protection. Knowing when to sell is much harder than knowing when to buy.

  2. cm |  May 14, 2010 at 3:30 pm

    Please, don’t even dignify the “b instead of an m” theory by repeating it here. That is similarly plausible to the Sep 11 rumor that a guy survived the collapse of one of the World Trade Towers by being in an elevator and sort of “surfing” the debris stream down to the ground.

    It’s insulting to one’s intelligence. And, worse, that it appeared to quickly that day when there’s no way they could have had any idea what happened strongly suggests to me that it was a public relations cover story cooked up immediately by either Wall Street insiders or government insiders or both. I don’t think that’s being too conspiratorial.

    I think the decline may have been real. With 60% of trades being computer-decided now and with many trades occurring on millisecond scales (or shorter!), I would not be shocked to learn that 1,000 point dips can occur. Network theory, in some models, predicts eventual wild oscillations of systems when the individual events happen on very short time scales, and given that there is an element of positive feedback here (that is, when a sell-off begins, other computers join in to cut their losses), it is even more plausible.

    • Sun |  May 17, 2010 at 10:20 pm

      With no clear explanation on exactly what caused the drop, all we have now are speculations and “b instead of an m” was one of the possibilities rumored initially. It could also possible that the drop was triggered by multiple events that happened almost at the same time.

  3. David Hilton |  May 28, 2010 at 12:17 am

    Stop loss orders are retarded. It’s like saying, “I don’t want to sell for the most money. I only want to sell my stuff when it has fallen dramatically in price.” What sense does that make?

    If you wanted an investment that cannot lose value, stick to CDs. If you can’t hack market volatility, increase your allocation to bonds and away from equities.

    This statement I disagree vehemently wish:
    “A significant—and real—loss in your stock values based on fluctuating consumer confidence is something you could see however, and is why a stop-loss order is still a great idea.”

    So less than 20 days ago, everyone holding a stop loss order got taken to the woodshed. Yet somehow you dismiss this and say they’re still a good idea? Ever heard, “Fool me once shame on you, fool me twice shame on me?” Is it going to take twice?

    Markets go up and they go down. If you can’t handle that, don’t invest in equities. That’s the only solution. Steer clear of stop loss orders. They should be renamed to “ensure loss orders” because that’s exactly what they do — only trigger when you have already lost a bunch of money.

    • Yo Prinzel |  May 28, 2010 at 7:54 am

      You make great points, although I still see the value of stop-loss orders for some investors. Some stocks do not come back up after going down and since none of us can really predict which will and which won’t, stop-loss orders are a tool that investors can use. Are there better hedges against losses? Of course. Should people play with equities if they can’t afford to lose money? No, they probably shouldn’t and I would advise them not to. But people take risks that they shouldn’t all the time. If they want to limit the losses they might experience with those risks but still get upside potential (which they may need to keep pace with inflation), I see no harm in them doing so with a stop-loss. There is no single right way to invest.