BULLS & BEARS: Stop-loss orders might cost you in long run

Every fortnight, my firm sends out a newsletter to clients, prospects and friends. In it, we opine on the stock market, the economy, pop culture and politics. If you read this column, you have a general idea of the tone of the letters.

This week, we got “fan mail” from neither a client nor a friend, but from a gentleman we had presented our services to about 18 months ago.

He started his letter stating he found our writings “informative, at times amusing, but always clearly in support of anything Republican.”

I took offense at that. What’s with “at times amusing”?

He believed I did readers of our newsletter as well as readers of my Feb. 20 IBJ column a disservice by poohpoohing stop-loss orders placed 8 percent below a stock’s current price.

His point was we all would be “far wealthier today” if we had employed trailing stop-losses in 1999 and early 2000. I don’t think so, and here is why.

One of the poster children of the go-go years for super returns was Dell Computer Inc.

In the 48 months from March 1996 to the market peak in March 2000, Dell rocketed from $1 a share to $59 a share.

But in 40 of those 48 months, the stock dropped more than 8 percent and would have stopped you out.

So instead of being the toast of the cocktail party because your $10,000 grew to $590,000 in four years, you would have been the dunce that got stopped out at $1.35 a share, or $1.60, or $1.65, etc.

Sure, had you not used stop-losses until the peak of the bubble you would be far wealthier today.

But had you consistently used tight stops, you probably never would have accumulated the wealth to begin with.

I know what you less-than-amused readers are saying. You are saying, “I picked a very volatile stock as an example, and in general the trailing stops would work.”

Let’s look at the S&P 500 instead and use recent history, say just since 9/11. In those 55 months, you would have been stopped out of the index 10 times.

The last three years have been the least volatile in over a decade, so normally the stops would have been hit even more often than that.

Well, if you get stopped out, you can always buy back in at a lower price, right?

Let’s say you get popped for a loss two or three times in the same stock. Are you really going to go back to that one again?

Stop-loss orders will keep you from losing, but may also prevent you from winning.

Republican leanings? I’d like to think the slant is more toward optimism than any political party, although I have enjoyed voting for winners the last few years.

My “fan” took umbrage with excerpts from a blog by Rich Karlgaard of Forbes magazine.

In it, Karlgaard points out that 60 percent of Americans think the economy is in lousy shape even though by many measures it is incredibly strong.

He cites the good GDP growth, the highest number of employed people ever, record home ownership, strong consumer spending, and a deficit-to-GDP ratio that is about average for the last quarter century.

So I’d agree with Rich that the glass is more than half full and eventually the market will respond. Enjoy the ride with no stops.