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May 27, 2010


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These anomalies can be solved by using stop-limit orders instead of stop loss.

That said, I do agree stop orders generally only succeed in you following a losing selling low strategy if you are using them for broad index etfs, etc. The place for them is in highly speculative individual stocks you only intend to hold short term anyway.

Ah, the infamous flash crash. I was SO CLOSE to buying in during the dip, but by the time I finally committed with a buy order, I had already missed it. I missed out on a 20% trading opportunity, but you know, it would have been ridiculously risky as well. :D

I agree that if you plan on not monitoring very actively, it is indeed better to buy-and-hold and forego any type of stop. Certainly, we can look in hindsight about what kind of stop woulda coulda shoulda helped, but it's hard to apply that as we move forward into the future.

Furthermore, traditional buy-and-hold strategy with typical mutual funds would have shrugged off that flash crash (even though it would still have posted a small loss on that particular day from the overall market). The average investor could have gone through their lives without never having heard or known about the flash crash and still do just fine.

Now, if you want to talk about actively trading individual stocks or ETFs, I've found that the best use of a trailing stop anyway, is to avoid any unusual activities that causes a bearish movement in your securities. That is, you're saying that, even if you're not entirely certain what's going on yet, whatever it is, something bad must be happening for the stock to slip x% from the usual market volatility, and therefore, you want out before whatever is causing it causes further erosion.

I used to use that method, but I don't anymore. Nowadays, I use some basic technicals and use limit buys and sells instead. That's because I believe that you're either going to monitor your securities very closely and trade with some idea of what's going on, or you're not going to trade it at all. Therefore, limit orders makes more sense to me anyways.

Still, regardless of what type of stops you use, you do have to constantly adjust it. Even with a blind trailing stop, whatever % that worked before may not work now due to the increased market volatility we are experiencing today.

As for the portfolio asset allocation, I have to say that is an extremely aggressive one. This, especially considering all the European debt issues that are floating around, foreign securities are currently under-performing domestic securities, and further weaknesses are possible.

On the other hand, I suppose it's possible that this is also a prime time to buy into the market on the "dip", but then, we're no longer talking about passive buy-and-hold. Then, we are talking about market trading and active fund management.

In which case, were it up to me, I would shift some of that foreign allocation, and even bonds, and shift it towards cash. Doing so provides security from potential upcoming foreign and bond market weaknesses, as well as keep a lot of powder dry for buys in the near future. Furthermore, cash helps to buffer the impact of any further flash crashes.

OR, simply go with something entirely hands-free and passive such as Vanguard Target Retirement fund and call it a day. That's basically all I have in my passive investment account. Set it, forget it, don't even think about tweaking anything.

Bottom line, I believe you either trade the market or you don't. But whatever you decide, I don't believe in doing some niggling "strategy" in the middle, as that is a great way for something to screw up.

But that's my opinion on it anyways. Great topic by the way.

Stop loss orders are a problem because people often pick round numbers. So I buy stock X at $55.35 and I say that I want to sell if it hits $50. Millions of other Stock X holders also like that price of $50 as a stop loss. When that number is hit, the market is flooded with sell orders, if there are no buyers the market for that stock could drop fast. In the computer age there may be Standing Buy orders for Stock X at $10. If there are few buyers when $50 is hit and all the stop loss orders are sent out, that standing buy at $10 could be executed.


Stop losses are a very important tool in money management. Sure, there are instances when they do not work so well, but they almost always serve a good purpose. If you want to avoid crappy execution prices once a stop gets triggered, you can enter a stop limit order, which becomes active at the stop price, but the active order will be a limit order rather than a market order.

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