Finance and stock-loss rule question?

Question

For any of you who know a lot about finance or stocks, I need your help on the following two questions:

1) What is the stop-loss rule, and what is the rationale behind its employment in portfolio management?

2) When may the employment of a stop-loss mechanism not be necessary of inappropriate?

Answer 1

there is no official rule....it is up to you to make it your rule...

Answer 2

stop-loss is not actually a rule.  It is a mechanism to prevent one from suffering more losses in stock price.  When you buy a stock say at a price of $50 a share, you can make a decision as to the amount of loss you are willing to suffer and set up an automatic stock loss at that price so that if the stock falls below that price, you will automatically be sold out of your position.  Stop losses can be set up at a particular price as say $48 a share or at a particular % drop in price as say 10%.

There is a danger is using stop losses.  The danger is that you might be whip sawed through the stop loss and loose your position.  This can especially happen if the stop is set too close to the buy price.

I may be incorrect on this point because I do not use stop orders at all.  I think they are mostly used by traders rather than investors.  A long term investor I do not believe would normally employ stop orders.  They normally buy stock based on fundaments not technicals and tend to stick with a stock until the fundamentals change.  They actually are likely to buy more of the stock if the price goes down rather than get stopped out of their position.  

Traders on the other hand I believe use stops to protect themselves against the market moving against them.  They are attempting to make gains on small price movements and can not afford for their positions to suffer too great a loss.

Answer 3

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