You have heard the term “stop-loss” before. Many investors, often the self managers tout stop-loss orders as their method of ensuring gains or protecting against big losses. Almost always they are wrong, and the stop-loss has the exact opposite result. The result more often is to stop future gains, pay more in transactions fees, trigger taxable events at inopportune times, and simply make less money than the investor otherwise would have by taking no such action.

Let’s give the definition to make sure everyone is on the same page.

Definition: A stop-loss order is an order to sell a security when it reaches a certain price. It is designed to limit an investor’s loss on a position in a security.

I believe I have said this before, but I will say it again, “a movement in price alone is never a reason to buy/sell a security.”

The decision to buy/sell a security needs to be based on a number of factors: economic outlook, sector outlook, industry outlook, company/particular security outlook, political outlook, category outlook, market cycle analysis, and on and on, etc.

Markets typically experience a correction about every 12 months. That means that using stop orders (depending on the order price) will often force an investor to sell positions on the decline, only to watch the same positions bounce back up. All the while with no fundamental change in the underlying security’s story.

Just because a security has dropped a lot in price does not mean it will necessarily have a strong bounce. Just ask Peabody Energy. Just because markets reach all-time highs does not mean they will soon have a downfall. New record highs could continue to be hit for a long time before another bear market. Just look at about every bull market in history.