This one is short and sweet. Set your stop losses at 8%.
Unless you have rock-solid confidence in your investment (AKA you would buy more if it dipped 90% or more), then set your stop loss at 8% of your initial investment.
The logic is simple.
If your investment drops 50%, you need to make a 100% gain to get back to zero.
Therefore, protecting against drops can have a greater impact on your long-term portfolio than catching huge gains.
Why 8% Below Buy-in?
Because a stock can drop 5%, make a 5% gain, and be less than a percent difference than where you started.
Meanwhile, if it drops more than 8%:
- You’re risking not just the capital, but the time waiting for it to recover (when you could be investing in other, better choices)
- Animal spirits may take over and drop it more
- A recovery of the same percentage as the drop <10% means you’ll stay within a percentage of your starting position (e.g. a drop of 9% and a gain of 9% still keeps with less than 1% loss of your start)
A stop-loss is exactly that: stopping your loss.
The loss curve is exponential. The more it drops, the amount needed to make it back exponentially increases.
Of course, if you want to protect against all drops, then keep everything in cash forever. You’ll just bleed out to inflation.
Otherwise, practice the stop-loss rule of 8%.
This rule is great if your investments regularly grow. If you’re the YOLO type, this advice wasn’t for you, anyway.
