07 Feb Should I set a stop-loss order for my stocks?

Q. If I was to set a “stop-loss” on a stock, what would be the recommended percentage drop to set it? For example, if the stock is at $90, should I set a 10% loss to sell at $81 or should it be 15%. I was never one for setting these but with stocks so high and this being an election year I fear a big drop coming in the market.
— Trader

A. When you have money in the stock market, you’re smart to want to limit your losses.

For the uninitiated, if you put a stop-loss order in place, a stock will be sold automatically when it declines by a certain percentage.

Ten percent is a common percentage for a stop-loss. Fifteen percent is commonly used, too. The right answer depends on your risk tolerance and the kind of stock you’re talking about.

Rather than think about individual stocks, you might want to look at the big picture.

Michael Maye, a certified financial planner and certified public accountant with MJM Financial in Gillette, said he’s not a big fan of stop-loss orders.

He says for most investors, it makes more sense to set the appropriate asset allocation and then rebalance so you don’t take on additional risk by becoming overweighted in equities.

“I recommend an individual have both an emergency fund as well as any money needed for short-term goals and spending set aside in lower-risk assets,” he said. “That way when the market corrects, which it will, an investor doesn’t need to sell their equity positions at the wrong time to raise cash.”

Maye said when using a stop-loss order, you can also suffer from unintended consequences.

“A couple of years ago there was a flash crash where certain stocks and ETFs were significantly mispriced — greater than 10%,” Maye said. “A person with such a stop-loss order would have had their position liquidated.”

That could cause a realized capital gain. If it is a short-term capital gain, it would be taxed at ordinary income tax rates, which is even worse for higher tax bracket taxpayers.

“My advice is keep it simple,” he said.

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This story was originally published on Feb. 7, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.