This article explains how a stop-loss strategy can help protect your portfolio during sudden downturns.
You'll learn the basics of stop-loss orders and discover how a trailing stop-loss can lock in gains when the market is volatile. This simple strategy takes the guesswork out of when to sell, helps reduce emotional stress, and allows you to stick to your investment strategy, so you can confidently manage your portfolio in any market.
Estimated reading time: 6 minutes.
Market crashes are every investor’s worst nightmare
Sudden, severe downturns can wipe out a big part of your portfolio’s value in a matter of days. While no one can predict exactly when a market crash will happen, you can take steps to protect your portfolio when it does.
One of the most effective tools for this is a stop-loss strategy. In fact, a well-implemented stop-loss strategy (a trailing stop loss is even better) might not only prevent big losses but could also help you turn potential losses into small gains.
What Is a Stop-Loss Strategy?
A stop-loss strategy involves setting a predetermined price level at which you will sell a security to prevent further losses. For example, if you buy a stock at $100 and set a stop-loss at $90, your position will be sold if the stock price drops to $90. This simple yet powerful tool can protect your portfolio from significant downturns by capping your losses.
Types Of Stop-Loss Strategies
There are mainly two types of stop-loss strategies, fixed stop-loss, and trailing stop-loss – which I use in my portfolio all the time.
A trailing stop-loss is particularly effective because it automatically adjusts upward as the stock price rises, allowing you to lock in gains while still protecting against declines. For example, if you buy at $100 and your stock rises to $120, a trailing stop-loss set at 10% would move up to $108, ensuring that if the stock price drops, you sell at $108 rather than $90.
Click here to see how to calculate your trailing stop loss correctly!
How Stop-Loss Strategies Can Help You Keep Your Gains
The key benefit of a stop-loss strategy is its ability to protect your portfolio during market crashes. During a crash, stock prices can fall rapidly and unexpectedly. If you don’t have a plan and stick to it, you might hold on to your investments in the hope that they’ll recover, only to see them fall further.
A stop-loss strategy takes the guesswork out of this situation by automatically selling your positions when they hit the predetermined level, saving you from the full impact of the crash.
In some cases, a stop-loss strategy can do more than just prevent losses, they can help you turn potential losses into small gains. For example: suppose you set a trailing stop-loss at 15% on a stock that’s been performing well. If the stock price rises steadily, your trailing stop-loss moves up with it, locking in higher and higher potential sell prices.
When the market turns and the stock price drops, your stop-loss will sell the stock before it loses too much value, allowing you to keep some of the profit you’ve accumulated.
For example, if you bought a stock at $100 and it rose to $150, your 15% trailing stop-loss would adjust to $127.50. If the stock then dropped to $127.50, your stop-loss would trigger, selling the stock and securing a $27.50 gain per share, even in a declining market.
Protecting Your Portfolio in Uncertain Times
You know market volatility and uncertainty is a part of investing we cannot ignore. While you can’t control the market, you can control how you respond to it. And a stop-loss strategy is one of the best ways you can do this.
It lets you set clear rules for when to sell, reducing the emotional stress of decision-making during turbulent times. Instead of reacting impulsively, you can rely on your predetermined plan that protects your portfolio from severe losses.
This not only helps preserve your capital but also positions you to take advantage of market recoveries when they occur. This clear plan of how you manage a crash lets you stick to your investment strategy which as you know is the key to your long-term investment success.
Conclusion
A stop-loss strategy is a powerful tool that can help you avoid severe market crashes and even turn big losses into small gains. By setting predetermined stop-loss sell points, you can protect your portfolio from significant downturns and reduce emotional stress.
It’s a simple but very effective way to ensure that you’re prepared for whatever the market throws your way.
Click here to see how to calculate your trailing stop loss correctly!
Stop-Loss Strategy Frequently Asked Questions (FAQ)
What exactly is a stop-loss strategy?
A stop-loss strategy is when you set a specific price where your stock will be sold automatically to prevent further losses. For example, if you bought a stock at $100 and set a stop-loss at $90, the stock gets sold if it drops to $90, limiting your loss.
How can a stop-loss strategy help me in a market crash?
In a crash, stock prices fall fast. A stop-loss helps by selling your stocks before they drop too low, protecting your money and saving you from bigger losses.
What’s the difference between a fixed stop-loss and a trailing stop-loss?
A fixed stop-loss stays at one price, but a trailing stop-loss moves up as the stock price goes up. This means it locks in gains while still protecting you from losses.
How does a trailing stop-loss work?
A trailing stop-loss follows the stock’s rise. For example, if you buy a stock at $100 and it rises to $120, your 10% trailing stop-loss would adjust to $108, so you can sell before losing too much.
Can stop-losses really help me make money during a downturn?
Yes, they can. If you use a trailing stop-loss, you might sell a stock after it rises, locking in some profit before it falls so far that it wipes out all your profit.
When should I use a stop-loss?
You should use a stop-loss whenever you buy a stock. It’s a smart way to protect your investment and reduce emotional decisions when the market gets rough.
What happens if I don’t have a stop-loss in place?
Without a stop-loss, you might hold on to a stock, hoping it recovers, only to watch it fall even more. A stop-loss prevents this by selling the stock automatically when it drops to your set price.
Is there a downside to using stop-losses?
The downside is that your stock might get sold during short-term market dips, and the price might recover later. But it still protects you from larger losses. This is why you should not set too tight stop loss levels. Research has shown that a 15% to 20% trailing stop loss works best.
How do I decide where to set my stop-loss price?
You can base your stop-loss on how much loss you’re comfortable with. For example, some investors set it at 10% or 15% below the stock’s purchase price. Research has shown that a 15% to 20% trailing stop loss works best.
Can I change my stop-loss once I set it?
Yes, you can adjust your stop-loss as the stock price rises or if your strategy changes. A trailing stop loss does this automatically. It’s a flexible tool to protect your portfolio.
Click here to see how to calculate your trailing stop loss correctly!
