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Trader Q&A: Are Stop Losses Good for Long-Term Investments?

See why our panel of trading specialists doesn’t advise using stop losses for long-term investments.

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[Lou] All right. Let's go to Christina from New York: "Should I use stop losses for long-term investments?"

[Kevin] Well I think from a long-term position standpoint I'll have to admit I'm not as interested in using stop loss on the positions that I consider to be long term in my portfolio largely because I'm investing in those positions for the purpose of diversification. I'm utilizing the idea that I can spread my money into sectors and categories of the market and I need that exposure, regardless of whether the stock goes through a poor move at any given time.

My thought to this extent with long-term positions would be not to overreact, yet again, to a big move in the short run, but rather to use that opportunity to evaluate why did it go down, should I be reviewing the position in a way that kind of changes the philosophy for me, something fundamentally different or altered with the stock in question. If so then maybe that means it's time for a change for the portfolio. But using stop losses seems to be an overreaction on a long-term position.

Now from a trade standpoint it makes perfect sense you want to step in, have an idea as to your upside, have an idea as to your downside, and then protect that downside from a trade standpoint. But long-term I would say no.

[Randy] The thing that's important I think also to mention on stop losses is that they don't work very well on an overnight basis. They're wonderful during market hours but when you need—what you need protection from most is a company that announces a poor earnings report, goes down—most companies like to announce earnings after market close. They have a bad earnings report, stock plummets. It opens weak the next day you get stopped out. And you're typically going to get stopped out at a really lousy price. So you have to be careful about that. Stop losses are wonderful tools but they have extreme limitations so you've got to be aware of those things.

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