INSIDE INVESTOR: How to minimise your risk with stop losses

Losses are an unavoidable aspect of investing. Minimising risk with a solid exit strategy such as a stop loss should help if your plans go south.

While it would be fantastic to be able to avoid losses when investing in financial markets, it’s simply not possible. Whether you are a beginner, an amateur or a professional, learning to control and deal with losses is all part of achieving investing success.

A lot of investors believe it is when you buy a stock that determines if you make or lose money; unfortunately this has very little to do with it as you don’t make money until you sell.

Usually, when an investment starts to head south investors hold on, hoping the stock will recover. Sometimes it does, sometimes it doesn’t, especially during viscous bear markets like the GFC. If a stock declines by 50 per cent, it must then rise by 100 per cent to just break even.

So how do we control this? The best way is to have a predetermined exit strategy should the investment not go to plan.

This is best determined before or at the time of purchase as it is the time when you can think clearly and objectively about when to exit. Unfortunately, when we own something we have a knack of letting emotions like greed and fear get in the way of a rational decision.

A great way to control losses is to use a stop loss, which is simply an order placed with a broker to sell a security when it reaches a certain price. .

One of the most common and effective ways to determine a stop loss point is to set a percentage of one’s account. The most common level of acceptable loss is two per cent of your account per investment. For example, if you have $100,000 in your account then you would set your stop loss so that you do not lose more than $2000 on each investment.

How you go about your investing will help you determine the best way to set your stop loss orders. The above method is a great place to start and will have you well on the track to controlling your losses.

Other methods that you may want to research further include stop losses based on underlying technical analysis of the security being traded or even volatility based stop losses, which takes into account how much a typical share may move on average in a day. These can be useful for more volatile types of investments like small cap stocks.