Can you think of a scenario in which a long-term investor needs a stop loss order?

Using a stop-loss order is highly recommended by and for most traders in the stock market. However, the Stock Trend Investing system does not have any stop-loss orders.

This is controversial. Why don’t I use them? We will explain here using a few different scenarios.

In summary, you can say that we do not use stop loss orders at Stock Trend Investing because we are long-term investors and not frequent traders. That requires some further explanation.

As long-term trend investors, we want to capitalize on trends that last many months or years. On average, we see that the long-term trend only changes direction once in the two or three years.

Stop loss orders are used by traders to protect themselves for a further decline in the market after the market has gone down already to a certain level or with a certain percentage. Often these traders buy and sell individual stocks or commodities and protect themselves in this way also again specific risks that they didn’t see coming.

Here are three scenarios in which you may think initially that you would need a stop-loss as a long-term index investor. But we think it is better not to have one.

Stop Loss Orders Make You Miss the Rebound

Assume a scenario in which the market index crashes while the long-term trend was pointing up. The index falls very fast and deep. For many stock markets, this happened for example in August 1998 and in May 2010. In those months, the market dropped between the 10% and 15%.

However, in each of these situations, the market indices recovered very quickly as well. Within 2 months, the market was back above the level it was before it dropped.

Suppose that you sold because of a stop-loss order after the market dropped by e.g. 8%. When would you step into the market again? I would not know how to define when to get back in again. You probably would have sold after the 8% drop and missed the upturn. That is an 8% unnecessary loss.

When the market is in a down trend, on a regular basis big monthly drops can occur. However, as a long-term Trend Investor, you are not invested in the market during a down trend and you would not need a stop-loss order.

Sometimes it Takes 2 Years to Get Your Profit Back

An example where a stop loss order would have been beneficial for almost any investor was in 1987. The long-term trend was up. But in 3 months, from September to November, markets dropped deep and steep. The Dow Jones lost 31%. And it took 2 years before the Dow was back on its level from before the crash.

Yes, shit happens sometimes. If you would have always worked with a stop-loss of 16%, it would have worked out great for you. You would not have sold your holdings in 1998 and 2010 and missed the upturn. And you would have been able to capitalize on the recovery after the crash of 1987.

However, this makes sense because we know now in hindsight how much the markets dropped and how long it took to recover. Suppose that the next drop that takes 2 year to recover is a drop of 20%. And suppose that the next 2 crashes that rebound within two months are about 17% deep. In that situation having a drop-loss order when the market has fallen by 16% would cost you dearly.

A last scenario is one in which the market in an uptrend, falls deep within a few months, stabilizes then and does not recover for decades. I haven’t seen such a scenario in the stock market history. It probably only happens in case of big, global and catastrophic events that lowers the global demand for products and services from one moment to another. In that situation, I have probably different worries than the value of my stock market investments.

Impossible to Set the Right Stop Loss Level

Thus the main issue with using stop-loss orders as a long-term trend investor is the difficulty in setting the level of these stop-loss orders.

When you set the stop-loss level too low, you will miss the quick rebounds after a steep sell-off.

When you set the stop-loss level too high, your order kicks in too late after most losses happened already.

My approach is that I accept that it may happen once in a few decades that I have to wait a few years to get my earnings back. That is OK with me since I know that in the long run I make good money in this way, spending only one hour per month of my time on it.

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Think good about the consequences before you start using stop loss orders.