WHEN you look back at your own experience in shares you would be odd if you didn't have at least one major loss or, at the very least, a large ''lost gain''.
I still have a ''position'', if you can call it that, in a crappy little stock that went from being worth $50,000 at the time of purchase to $180,000 about a year later and is now worth just a few hundred dollars.
I remember saying, if it ever gets backs to 9¢ ($180,000) I'm selling it. It never did and I just hung on into the death.
Advertisement: Story continues below
Long-term investment, it seems, has one major flaw. It trains you to ignore shares that fall in price.
Stop-losses, or ''stops'', are little more than an effort to control that weakness, to cut losses while letting profits run. They are a discipline, a mechanism designed to point out to you unemotionally that a trend has changed against you.
They can be used by any investor on any timescale, even long-term-value investors and the people who need them the most, the wealthy people with big individual stock positions.
Stops can be set in many different ways. This week we'll look at technical, or mathematical, stops. Next week we'll look at more subjective stop losses.
Most technical stops have variables, inputs, that you will vary yourself depending on what sort of stockmarket operator you are.
Traders use tighter stop-losses and use shorter periods for their data. Long-term investors will use wider stops and longer, traditionally weekly, data.
Most are used in combination with each other. We cannot possibly explain stop losses in 700 words, so here is a taster. The traditional stops in short form:
■A dollar-based stop-loss and profit stop. I'll sell when I've lost $1000; or, I'll sell when I'm up $1000. It's a bit arbitrary but easy to measure and understand.
■A set percentage stop-loss. If a stock falls a certain percentage from the buy price, sell it. Pretty obvious. The longer the time frame, the bigger the loss you will tolerate. Investors might use 10 per cent, active traders less.
■A trailing stop-loss. Same as a set percentage stop-loss but you use the highest price hit since buying the stock rather than the buy price as your reference point. This is perhaps the most commonly used stop-loss mechanism but it takes a bit of work to monitor. The beauty of a trailing stop-loss is that it allows you to lock in profits as well as stop losses and it also ''locks in'' a profit when a share price has risen enough.
■A chart-based stop-loss. There are lots of these. You sell when certain technical analysis-based triggers are struck. An obvious one would be when a support and resistance level is broken; when a stock falls below support. There are many well-developed technical signals designed to tell you when to sell. Most traders combine several of them.
■A volatility based stop-loss. This is what we use. Stop-losses based on a measure of volatility. Selling when the stock falls two times its average true range, for instance. Lost you there, no doubt, but the basic message is that stop losses are wider on more volatile stocks and tighter on boring stocks.
■A percentage of capital stop-loss. I'll sell when I've lost 2 per cent of my total capital in this one stock. This is a technique used by traders who practice risk management at a more scientific level. A focus on ''capital at risk'' is used to do more than set a stop-loss, it also dictates the size of the positions you are prepared to take (position sizing) and the number of trades you can take.
We have only scratched the surface. The basic message on stop-losses is that something, anything, is better than nothing.
Using stop-losses means you have a plan that means a ''certainty of action'', which means knowing what you are going to do after your purchase. There is tremendous value in that, tremendous peace of mind; and it is so much better than making it up as you go along.
Marcus Padley is a stockbroker with Patersons Securities and author of sharemarket newsletter Marcus Today. For a free trial, go to www.marcustoday.com.au