CHAPTER XXI. STOP LOSS ORDERS
A "stop-loss" is an order to your broker to sell you out if the market sells down a certain number of points. Many speculators place stop loss orders only two points from the market price. The idea is that when the market starts to go down it is likely to continue going down, and by taking a two-point loss you may save a much greater loss. It also can be applied to a short sale, when you give your broker instructions to buy in the stock for you if it goes up a certain number of points.
We read so much in the financial news about stop-loss orders or merely stop orders, which is the same thing, the average reader is likely to get the idea that it is something he must use for his own protection, but it is our opinion that it is something that should be used very seldom by those who trade along the broad lines recommended by us. If your purchases were made in stocks that were very cheap, you should continue to hold them in case of a reaction. If you bought them outright or on a substantial margin, you are not in danger, and you should look upon your loss merely as a paper loss. In the great majority of cases, you will be a great deal better off to hold on to your stocks than you would be if you had a stop-loss order.
A large number of stop-loss orders is a good thing for the short interests. Let us take U. S. Steel again, as an example. Suppose it is selling at 94 and it is believed that there are a large number of stop-loss orders at 92. The short interests may sell the stock heavily and force it down to 92. Then the brokers with stop-loss orders would begin to sell; that would force the price down still lower, and the short interests could buy in to cover at this lower price.
Therefore, we believe that stop-loss orders are a bad thing and, as a rule, do not recommend them.
There is one instance where a stop-loss order can be used to advantage, and that is near the top of a bull market. It is impossible to tell when the market has reached the top. If you sell out too soon, you may lose a profit of several points. Of course, it is better to do that than to take a chance of a large loss. In that case, you might instruct your broker to place a stop-loss order at two or more points below the market, and keep moving it up as the market price moves up. Then when the reaction does come, he will sell you out and prevent you from losing a large part of your profit. That is about the only instance where we recommend a stop-loss order, but we do recommend it to our clients sometimes, although seldom.
If the stock you own is selling at more than 100 we would suggest that you make the stop loss order at least three points from the market, but for stocks selling below 100, a two-point stop-loss order might be used. However, the number of points should be decided upon in each particular case. In the special instructions to our clients, we tell them when we think they can use a stop-loss order to advantage.