When is the Use of Stop Loss Orders Warranted?

Stop losses only serve to lock in your loss in your stock market dealings. First off, let's take the case of a spread bet on a stock for which an announcement comes out bad and the stock drops to 70% of its value and you decide to take your loss and close your spreadbet. Then, later that day they issue a correction they got it wrong the stock goes to 120% its original price. That's how the markets move; there is just as much chance of a price going up or down.

To start with, if you could get out for no cost, then the stop loss has zero effect on your expected profit or loss. You will just as likely stop out of a position that would have gone back into profit as you will stop out of a position that would have lost more money.

In practice, this means that you turn a frequent profit, or a less frequent large loss, into a certain small loss. Overall there is no net effect on the expected profitability of each deal. However, your stop-loss does not tend to get you out at mid. It tends to cost you, furthermore, it tends to cost you about the same as the entry spread, so doubling your expected loss.

No matter how you choose to run it, it is expected to make you a loss. The loss is probably only about 2% per trade, so some people, through sheer statistics, will come out ahead. This is just the same as with walking into a bookmaker's and betting on the horse with the nicest name.

To repeat it very clearly again, stop-losses do not save you money. They increase the number of down-days, they reduce your expected profit, and they reduce the number of hugely down days. They turn very many winning days into losing days, in exchange for removing "utter disaster" days from the calendar.

So in essence, not using a stop loss enables me to invest in a repeated game situation and leaves the possibility for an open position in a heavy loss to eventually turn into something profitable, rather than taking the loss as soon as it hits the stop loss and losing out on the possible profit of a turnaround.

When is the Use of Stop Loss Orders Warranted?

But there is some point in the position that you have to take scope of things and actually cut a loss short rather than just watching the news and situation get worse surely?

In all instances you have to evaluate your position, look at the reasoning behind the loss/gain and decide whether these unfavourable / favourable conditions are going to continue or not or if you think the market is wrong or right. But betting on one company or one outcome is very risky. I personally wouldn't bet anymore than what I couldn't afford to take a 100% loss on and walk away from.

The only problem I see with the above reasoning is if you get a margin call and you get in way over your head and risk more than you're willing to keep the open position. Secondly, the cost of keeping such a position open (which may have been for a few weeks) could turn into something much longer term (assuming we're hoping for a mistake or some good news).

An ideal website to visit, to start learning about spread bets and margin trading is http://www.financial-spread-betting.com who offer a comprehensive FAQs section relating to stop loss orders and general stock market dealing.

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