Something burning? Hope it's not your dream of retirement

YOU can't teach an old dog new tricks. Which is why, despite all the financial logic, you can't get those stuck-in-the-mud, long-term, set-and-forget investors to use stop losses.

YOU can't teach an old dog new tricks. Which is why, despite all the financial logic, you can't get those stuck-in-the-mud, long-term, set-and-forget investors to use stop losses.

Face it, computers are just too hard, and who wants to be a trader, a manic obsessive with sunken eyes and pale complexion, mayonnaise dripped down their T-shirt stuck in a darkened room trading online and never seeing the light of day? God forbid. And anyway, if your grandad had used stop losses he'd have sold those BHP shares back in 1886.

If that's as far as you are prepared to go to protect your retirement, then fair enough. You're a hopeless case and you will just have to rely on the market always going up. You never know, you might be right.

But you're ignoring the fact that if you'd used even the laziest of stop losses you might also have sold those ABC Learning and Babcock & Brown shares and you might not have lost 54.5 per cent in the GFC and saved yourself 13 years of average returns, going nowhere.

But for those of you in the "I've got to live off this money" camp, you might want to do a bit better and this advice goes out to you. Some basics. A few things you may not realise about stop losses:

You don't have to become a trader. You can still be a long-term investor and use stop losses, you just use longer-term parameters on exactly the same principles.

There is no Holy Grail method for calculating stop losses, there are just a lot of different ways. Best you keep it simple. In our experience the rather silly truth about the fancy ways of calculating stop losses, trailing stop losses and stop profits is that they take many different routes to come to just about the same answer. We use a fancy stop loss that adjusts for volatility but using daily data most of the stop losses end up around 5 per cent below the share price, 8 per cent for a small volatile stock, 3 per cent for something like Telstra. And when we trade for more relaxed longer-term investors and use weekly data the stop losses tend to come out at about 10 per cent below the share price (6 per cent for stable stocks such as Telstra and 12 per cent for stocks such as Fortescue Metals).

There is no magic in a stop loss 99 per cent of the value of using a stop loss, especially as a lazy investor, is that you are provoked into thought and action. It's not "sell or die" it's "Wake up, you're losing money".

Your broker won't do it for you, because if they say they can, they won't be able to go to the toilet in case your stock goes through the stop loss and you sue them for missing it. Some online broker software can handle stop losses (contingent orders) but without that you'll have to do it yourself.

You don't have to watch the stockmarket all day, not as an "investor". Check your prices and adjust your stop losses once a week if you like, once a month if you insist.

Stop losses aren't just for bear markets. If anything they are more important in a bull market because they help you take profits, something you set-and-forgetters are particularly useless at. To use them as a "stop profit" you simply set them below the highest price the stock has hit since you bought it and adjust the stop losses up as the shares hit new highs. These are called trailing stop losses.

You don't have to sell when a stock hits a stop loss. It's not an instruction, it's an alarm. It is alerting you to the fact that the share price has gone down, that's all. It's up to you what you do about it. I generally go and have a look and if there are no extenuating circumstances just sell working on the basis that I can always buy it back if I want but for now the share price is telling me something and it's usually right.

You're not supposed to lower a stop loss except to adjust for dividends and adjustments to share price histories after things such as rights issues. Otherwise they are on a ratchet.

If a lot of stop losses go off in succession they are telling you something. That the market is going down. You might want to react to that.

Ultimately stop losses do little more than that buzzer on your oven that says, "Something's burning!" Your retirement perhaps.

Marcus Padley is a stockbroker with Patersons Securities and author of stockmarket newsletter Marcus Today. For a free trial go to marcustoday.com.au. His views do not necessarily reflect the views of Patersons.

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