Stop Loss in Value Investing

Q&A: Questions & Answers Investing Basics Q&A
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Dear VP members,

I have been reading this fascinating book ‘How I made $2m in Stock Market’ which talks a lot about stop loss. Even though the author is a short-term trader, the book is a worthwhile and pleasurable read for a newbie like me.

I have jotted down some of the questions that occurred to me as I was reading the book:

• Is stop loss a relevant tool in value investing – is it more useful for newbies?
• Do you use stop loss regularly in your investments – even for a long term investment horizon?
• What is the right way to use a stop loss in a value / growth investing process?
• How have you effectively use stop loss – how do you revise it as the stock moves up?
• What is the margin that you use for stop loss – I understand this depends on the volatility of the stock in question?
• What is your philosophy behind the whole process – how much does a share has to go down from your original investment levels for you to take a second look at your original reasoning?

Would be really great if the seniors provide their thoughts on this

Thanks!
Sathya

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Hi Satya,

Let me share my views with you on this. Investing needs to be business like. So before investing we need to know why we are investing in any given company. We usually think that since markets are not efficient every situation in front of us appears to be a bargain in some sense(availability bias). However as Howard Marks says," The market is efficient most of the time", so whatever we are looking at most ration people out there are looking at that too. To beat that market we need to know what others don’t know and in this process we need to dig deep and deep.

Knowing a situation in detail can be expressed in a small story. This story is our understanding of the company and needs to be attacked for all possible criticism.

Now once we develop a story, we need to know what is the trigger to unlock the value and what are the triggers for destroying the value.
If we feel the that the stock price is going below its value due to irrational reasons, something like Greece than we should not trigger stop loss. However if the original story is disturbed or exposed to a -ve black swan, we should cut out losses. In lynch terminology “stop watering the weeds”

Regards,

Sunny

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Beauty of the market is both buyer and seller thinks they are acting correct. Whenever you want to sell stock because of its price down think like “You don’t have that particular company shares in your demat account, you know the company business very well and you have enough money”.Now what is your decisions? Obviously in most of the cases its BUY.
So the same YOU acts in different ways depends on different circumstances.

There are different reasons for the fall of the stock price. Mostly its based on macro factors. Remember what happened in September 1st week. All shares were down by 20 to 30% because of global cues. If u had followed stop loss obviously u had to sell most of your stocks. But after one month market almost recovered. So you would have lost money if u followed stop loss.

In my opinion instead of following stop loss we must track the factors and if factors belongs to that particular company then we must take decision accordingly.

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also see trailing stoploss…use it with GTD order…
this is best combination for any value investor…but if u r looking fr holding fr long term(basically to avoid capital gain tax of 15%) then it may nt b a good option as it will some day either achieve the target mentioned or stop loss wud b trigerred…
best fr investors who want to sell on a crash situation nd buy back after prices hav stabalised nd at lower levels…

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I have question about how frequently one has to place stop loss. If I buy a share for Rs 100 and I have to place stop loss on 90, can I do it “one time” and forget it ? In other words, once placed, will that instruction remain till I change it or do I have to do it periodically? Or is their expiry date on the stop loss instruction?

In US, I can place a "buy/sale " call and it will remain for 6 months. In other words, in six months if price hits my target, it will execute the instruction( for buy call, I have to block the money for buying). I am told I have to do it on daily basis here in India. Is that true? If so, putting stop loss becomes a daily affair. Look forward to expert’s opinion on this.

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It depends on the broker you are using. I use zerodha and it has no such option and stop-loss needs to be set daily.

G1

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There are brokers ( like Sharekhan, others may also be there ) who have a facility to place orders as GTD, Good Till Date, which usually is 1 month from current date. You can place orders for buy or sell at a price at which you want it and select the date. And you can change the rates or the date frequently as per your need.
A Very useful tool for your have a longer term holdings, where you place an order and forget about it and still not lose the bargains on some extremely volatile days, even when you are not in front of the system. They only ask for margin to place the order (where you can very well use your existing stocks to keep as margin, atleast to place the orders)

Sharekhan also have options to place Bracket and Trailing stop loss orders. I don’t know how to use these features, but for someone who can find benefit from this, it can be an added advantage.

This GTD applies both for Buying as well for Selling in Cash market / equities. This is not applicable for derivatives.

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That is a very good feature. HDFC also has GTD orders but they lien mark your funds for order. Thus possible only with cash and not margin orders. This makes it useless for placing orders under GTD as funds get blocked for the whole period where GTD order is active.

Do Sharekhan have SOR (smart order routing - best price from BSE/NSE is taken)?

Which other broker does margin based GTD and SOR orders?

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But fund blocking would be applicable for only “buy” orders, right? For sell orders, they have your shares in the Demat account to block. I am more interested in “sell” orders as a stop loss.

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Hi VP,

I am trying to find a simple excel based trailing stop loss calculator- fixed % model. If anyone has may pls share. I have the logic but not able to put all of that in a single cell. I have to calculate each time from the latest high, apply % retracement & indicate sell/hold signal.

Also your thoughts on a combination of 2 strategy ( Momentum Long + Trailing Stop Loss). Please share your experience & insights on utility of the above startegy, benefits over lets say buy hold etc.

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You can plausibly use the following in google sheets. Use the value of the ticker you are interested in and also the trailing stop loss you intend. Below I have put 0.75 which is for 25% drawdown.

=if(GoogleFinance(Ticker,“price”)/GoogleFinance(Ticker,“high52”)<0.75,“SELL”,“HOLD”)

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Is it advisable to increase trailing stop loss % ( correction/holding patience) as we clock more % gains over buying price. I was experimenting with Fib retracements and roughly summarised the approx SL % from peak. Seems natural as when we have no gains or minimal gains to start with, we have tighter SL. As we sit on bigger gains , we may give the stock better freedom to correct & rise longer. Need to understand if this makes sense.

image

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Dear all,
In HDFC Sec the stop loss feature is valid only for the day.How to put stop loss for longer period unless you keep monitoring the stock price every day. Anybody any experience or know how will be appreciated.

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Reviving the not so active thread :slightly_smiling_face:

I have been reading on SL and TSL and what major research and back testing says is it works great with momentum investing. But also very much doable with value investing. TSL especially, gives a non emotional exit mechanism, allows winners to run, cuts the losers, books profits, saves from massive drawdown and likes. 20% below last high is kind of thumb rule for better returns. Many times its superior to buy and hold.

Would request members to share their experience of pros and cons of TSL. I believe, real experience is better than research or back testing reports, which are under controlled environment.

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Sharing an article by quant investing… Hope you all find it a nice read…

https://www.quant-investing.com/blogs/general/2015/02/16/truths-about-stop-losses-that-nobody-wants-to-believe

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Often we end up having 15 to 25 stocks in a portfolio. Now a days with huge flow of information like blogs, videos, apps, stock funda analysis website… Stock picking has become much easier than say what it was a decade ago. Now retail investors are aware beyond PE and EPS. RoE, RoCE, Peg etc are well researched.However valuation still remains tricky as always been.

What I find is not so much research in exit and selling strategies. By that I don’t want to undermine buy and hold, but often investors hold as they don’t know how and when to sell.

There are few exit strategies, but most often its panic selling or quick profit booking, which remains the frequent selling strategy.

I find TSL a systematic strategy, a relatively simpler one to execute, devoid of various Bias, compared to decisions basis market valuation, target achievement, capital allocation, fundamental degradation etc.

However, its my broad opinion, not backed by real experience or feedback.

Let’s say a stock falls by 20% from latest peak. TSL screams SELL. We have 2 options here.

  1. SELL
  2. Buy More to average down if its high conviction stock and fundamentals are not significantly damaged.
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I may be wrong, but I believe there is nothing like ‘averaging’ in the stock market. If I have bought a stock at two times, say, @500 and then @200. Totalling 1000 shares, when I sell them, the profit of the first lot will be calcuated taking the price at 500 each, and of the second lot at 200.
So when I have these 1000 shares, and an opportunity comes along to buy at 300 a share. Am I averaging them? To my mind, I should buy only if the share at that time is worth ₹300.
Please correct me if I am getting it wrong. Maths is not my strong point, and as for the stock-picking, we learn something new every day.
My doubt relates to putting stop-loss. Do we do that accross the board? On the one hand such an action may be called taking the emotion out of the business, on the other hand it may be considered indiscriminate, mechanical or even thoughless.
It has been mentioned in this thread that in a transaction, both the buyer and the seller assume that they are doing the right thing. The seller protecting himself from losses, and the buyer considering buying a stock cheap.
May be stoploss may be applied taking some relevant factors into account. One is the pupose of buying/holding the stock. Experienced investors advice maintaining a journal.
In the recent fall in the market, shares were going abegging at mouth-watering prices. On 20th Feb, L&T was ₹4418. So, a 5% stop-loss would have been triggered at ₹4197. A 10% at ₹3976.
Then, what does the investor do then? I feel so handicapped because I am technical analysis illiterate. Would that help? The stock in fact went down to ₹3342. So, are we assuming an investor with a great foresight who would have bought it back at that price?
Ultratech announced foray into cables manufacturing, and the Polycab shares came crashing down. That would have triggered a stop-loss sale. The same had happened when there was some income tax related issue.Yet Polycab is nearly double the price since then.
This frequent selling and of course having to buy back the stocks also entails income tax payment and brokerage, STT.
So, may be I don’t put a stop-loss in stocks which inspire faith, but in the stocks which are not on so much firm ground. If I can give an example. Perhaps I should not worry about an L&T or Ather, but about many solar and gas stocks that I have accumulated? Who knows how soon there may be a solar panel glut in the market or the gas problem may have sorted itself out?
As you may see, my head is reeling. May be cooler heads may advise us.
Disclaimer: The stocks mentioned do not imply any recommendation or advice.

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Very true. Stop loss is a very difficult subject, and I have had my share of regrets - both from not having a stop loss, as well as from having one! After years of trial & error, I have ended up with the process described below. My thinking is evolving on this subject, and it may change in future.

  1. For my long-term holdings, I don’t have a stop loss. By ‘long term’, I mean stocks I hold for more than 1 year. I avoid qualitative judgements such as “core portfolio”, “high conviction stock” or “blue chip” stocks etc. I simply go by the date of first purchase. If I am holding a stock for more than 1 year, I presume I know enough about it to decide when to sell. Stop loss is only during the “learning period” which is 12 months. My long-term holdings such as Acutaas, Pricol, Ajanta, Sakar, Axiscades, VBL etc. come under this category.

  2. For new stocks I put a stop loss, but it is only a price alert. Some experts advise putting a GTT order “to take the emotion out of it”. But I first want to formally & thoroughly evaluate why the stop loss got hit rather than do a mechanical sell.

  3. I am more lenient with stop losses triggered by macro / market wide factors but more worried when there is a company specific factor involved or no reason is apparent.

  4. Mentally (since they are just alerts and not GTT orders) my stop losses are graded stop losses. 1/3rd for -10 %, 1/3rd for -20 % and 1/3rd for -30 %. This way, the maximum exposure on any stock is -20 % of the original position. But as stated earlier, hits are occasions to evaluate the positions, so the actual loss may be lesser than 20 % if I exit fully before the -30 % is hit.

  5. If I average up during the first 12 months, the stop loss can also move forward - linking it to the last purchase price, which reduces the risk on the earlier purchases even further.

In practice, my experience is that -20 % gets hit rarely and I have never hit -30 % stop loss. If stop losses are getting hit frequently, one has to work on getting the entry price right. Or keep the starting position so low that there is no need for a stop loss.

Recently during the market crash in March, this system worked fine. A few alerts got hit because I have significantly revamped my portfolio beginning November this year, and there are many stocks in the “learning period” category. I have exited many long-term holdings (e.g. Sumitomo, Tinna Rubber etc.) and adding many new ones. My response to the crash varied on a case-to-case basis. For example,

I bought Azad Engineering in November. When I came across this stock & analysed the business, the story seemed so compelling that I couldn’t resist buying into it. The only issue was high valuation, so the stop loss was set. When it got hit -10%, I sold 1/3 of my holding. It never went to -20%, the market recovered and the stock is now at an ATH and I have more than recouped my losses

I bought Techno Electric in December. At that time, the market was already in decline and promptly, the 10 % stop loss was hit in January itself. I sold 1/3 of my holding. In March the stock hit -20 % trigger but instead of selling more, I actually redeployed the earlier money back by buying more. The reason I did not sell Techno a second time but bought more was because it was a market-wide crash, bearish sentiment was at such an extreme that I just decided No Way I am selling in this panic. I was also comfortable with the company valuation, which helped. Today the price is above my original purchase price.

In cash of a few more stop losses which got hit in March, such as SJS Enterprises, IGI etc. I have ended up selling 1/3rd and continue holding the rest. None has fallen by 20 %. I also bought many others lately where even 10 % was not hit – TD Power, Inox India (before SOIC set it on fire! :grinning_face: ), OBSCP (my first SME stock), Vishnu Chemicals etc. and so today the portfolio is at ATH.

To summarize, for me stop loss is just a trigger to pause, think & re-evaluate thoroughly. Check for blind spots in your thesis, if any. May be reduce your exposure, but don’t exit completely unless you realize it was clear mistake. This is where I am today on this subject.

(Disc.: All clearly mentioned)

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