Sleep Better at Night: Stop Using Stops!
Today’s Take: The market is there to serve us, not guide us.
“I think I’m going to throw up…”
I was sitting at the conference room table in the clearing brokers’ lounge with Pete. After the close of the trading day, we would all gather there to tally up our trades.
Pete was a smart guy and great trader. I’d seen him have days where he made $10,000. Back in 1983, that was serious money.
“Quick, get me the wastebasket.”
Without picking my head up, I said: “C’mon Pete, stop being dramatic. You’re not going to throw up.”
I was wrong. He threw up all over the conference room table. It missed hitting me by inches.
I stepped around the mess and helped Pete to the water cooler. I figured he must’ve had a really bad day and lost big.
But when he was feeling a little better, I found out that was not the case.
Pete told me that before the stock market opened that day, his research was pointing to the start of a big leg up in the bull market. Throughout the morning, he kept buying.
And he was right. The stock market was flying. By lunchtime, he was up by more than $25,000.
Then, wanting to protect his gains, he placed a stop loss order…
If the stock market fell by a certain percent, his position would sell at an arbitrary dollar amount that he set. In this case, he would lock in around $10,000 of profit.
After trading higher all morning, the stock market finally took a breather in the afternoon. And Pete’s stop was triggered during the pullback.
For a few minutes, Pete was strutting around the trading floor like a peacock, celebrating his locked-in profit.
What happened next was what made him lose his lunch by the end of the trading session…
Don’t Let the Market Shake You Out of Bigger Profits
The market started soaring again.
Pete waited for it to fall again so he could enter a new trade. But it never happened. By the close of trading, Pete’s original position would have made him $100,000.
Pete let a huge gain slip away. He left $90,000 of profit on the table!
He’d done so much right. As soon as the opening bell rang that morning, he was right on the direction of the market.
And he’d taken a position with conviction. He even told me that his research was telling him that this move up should last for weeks, not just days.
But the one thing he did wrong was let the market shake him out of the trade. He cut short his winning position just because of short-term price action.
And letting a big gain get away like that — especially when you do everything else right — is like a punch to the gut.
In fact, over the nearly four decades I spent on Wall Street, the trades that hurt most weren’t the ones where I lost money.
They were the ones where I left lots of money on the table by doing something dumb … like selling out of a winning position just because I wanted to protect my profit. That’s dumb as dumb can be.
By using stops, you’re basically saying: “I’m not that confident in my research.” And you’re throwing your position at the mercy of the stock market.
That’s why intelligent investors don’t use stops. Because volatility is the price of high returns. You can’t make gains of 500% or more without expecting to sit through 20% to 30% declines…
Only Sell When the Facts Change
When I started my money management firm, I was only 22 years old.
One night I woke up in a cold sweat. I was starting to worry if I was making the right move. So, I went to see one of my mentors for a pep talk.
This guy was a legend on Wall Street. Just being around him made me feel great.
He bought stocks and held them for decades. It was public information that he bought IBM and Motorola back in the early 1960s and never sold. His net worth was in the hundreds of millions.
As I was heading out of his office that day, I asked him for one final piece of advice. His face got all serious and he said…
Never let Mr. Market get you out of a position. Only sell when the facts — not the stock prices — change.
That was back in February 1985, and I haven’t used a stop order since. Investing has been much less stressful because of it. And I’ve slept much better at night.
When you use stop orders, you take all the hard work of research and analysis and throw it in the trash. Stops take you out of a position when the price changes … instead of when the facts change.
That’s no way to grow your account balance.
So, instead of focusing on the wiggles and jiggles of the stock price, I focus on the business. Because if the business continues to grow, the stock price will eventually follow.
Investing doesn’t need to be complicated. You deserve to have your investment work hard for you, not the other way around!
And making money in the stock market can be as simple as buying a few great businesses at bargain prices. Then, you sit back and wait.
That’s the way to build a huge nest egg when you retire … buy your children or grandchildren their first home … or fly first class just for the heck of it.
Founder, Alpha Investor
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