Regarding stop losses, I have heard that they are visible to market makers and that they can manipulate stock prices to result in your stop loss being triggered and then the stock runs right back up. Are stop losses really good protection? (January 9, 2002)

  We use stop losses carefully, and we discuss their various types and uses in our online seminars. One main theme we teach is that stop losses are not perfect by any means, and they can fail you when you need them the most, e.g., when a stock has bad news and plunges. Your story is another one of the pitfalls most learn about personally when they start investing. Back in 1995 I recall I found a good little stock in the $10 range. It was a relatively new issue and it had a lot going for it. It made a strong move up to 12.50, tested the move, and started back up. I bought in with the intention to let it run as it was a newer issue and was looking as if it had some legs. I was using a new broker, and when the stock ran from right at $10 to $17.50, I received a feverish call about how I should protect my gains, etc. At times I used pre-set stop losses on very large stocks with a high average trading volume for this very reason: there was less likely to be manipulation of the price. This stock traded about 100,000 shares average per day; it was getting a following. Well, the broker convinced me that since I was not going to be able to watch the stock I should put in a stop loss instead of just using a mental stop loss and keeping up with the stock a couple of times a day. Well, it was on the Nasdaq, and sure enough after the loss was put in place, even though the stock was showing a nice gain on some good volume that session, the price just ran right down to my stop point, I was taken out, and it just rallied right back up. A red-faced broker called with the news.

Stop losses are not perfect. This is one of the things that can happen on thinly traded stocks. There is no perfect safety net for stocks. I often use mental stop limits, pre-set levels I want to consider selling whether 7% from my buy point or under some support (moving average, trendline). When I do set stops, I usually use a stop limit where I am saying I want to sell at a specific price, not at any price once the stock moves past my stop order. Also, it helps to use them on very liquid stocks with large daily trading volume. Less chance of manipulation and less chance that your stop order will be bypassed on any downside move.


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