How to use stop-losses to maximise profits

1 mins. to read
How to use stop-losses to maximise profits

In my opinion, investors/traders don’t spend enough time on putting together a strategy that helps them decide when to get out of a profitable position. All of the effort gets channeled into finding a perfect system for where to get in – which of course doesn’t exist! But where you finally get out is what dictates your ultimate profit or loss, so let’s redress that balance. We will start off with the simplest approach, using previous levels to identify logical places to book profits.

Let’s use a trading example to identify the first method. The US Dow Jones index is always a popular one with those who use products such as spread betting for their trading. It’s a market that most people have heard of and, even on a dull day, it will travel through ranges in excess of 50 points – and frequently an awful lot more when really moving.

Since the US Presidential Election, American stock markets have been strong and regularly setting fresh all-time highs. The strategy of “buying the dips” – waiting for the market to recover and push higher still – has worked well. The middle of May saw the Dow sell off. In historical terms it was not a major fall, but as we had got used to the market grinding higher for months, it did come as a bit of a shock to some. Our savvy trader may have decided that this was just another buying opportunity, so got in on 18 May as the market showed the first signs of stability….

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Comments (2)

  • Robin Chatterjee says:

    Sounds very complex and time consuming. Is there no easier and shorter(in time) method of these “Stop Losses” situation?

  • TonyA says:

    I’m not impressed by this article: it is far too simplistic in its recommendation that people stay with their occupational pension schemes, and fails to consider any of their negatives. For example:

    1. if you leave a scheme, your protected rights will typically only increase by CPI inflation until retirement. This is a pathetic rate of return on the implied capital value of your share of the “pot”, which might go on for 10, 20, 30 or even 40 years between when you left the scheme and when you are finally allowed to retire. Think what the capital value (and the income taken in the form of dividends) would be worth if you pulled out the capital and invested it directly in equities via a SIPP instead. Likely capital gains from the stock market over 20-30 years would be far, far greater than CPI.

    2. You are only allowed to start drawing benefits when the scheme permits it. You might be dead before you reach age 65, 67 or whatever. With a SIPP, you can make your own decisions about when to start drawing benefits and at what rate: you can “retire” early, for example, and use the SIPP dividends much like rental income from a property investment, while you continue to work or perhaps set up a new business or perhaps help pay for a parent’s social or nursing care for a while until they pass away. The point is that a pension fund is likely to be only one element in a portfolio of people’s assets and sources of income, so flexibility is a huge bonus, both in terms of balancing life’s changes and potentially leading to a better, larger overall set of assets and opportunities.

    3. If you are single and you die before you can take the occupational pension, your estate typically loses the entire capital value. All those years of pension contributions are completely wasted. If you die after starting the pension, no-one else is allowed to receive anything: your loss, the pension scheme’s gain. With a SIPP, in contrast, you can nominate a beneficiary in your will, because the pension can be inherited.

    4. If you are married and you die before you start to take benefits, your spouse may not receive anything, or will only receive what the occupational pension trustees decide is appropriate (you are at their mercy). If you are drawing a pension, your spouse typically only gets 50% after you die. With a SIPP, in contrast, your spouse will still get 100% of your current drawings, or less or more, as they decide: they inherit the same pension pot as you were relying on. And if the SIPP has any capital left when your spouse then dies, your children can inherit too. With an occupational pension, only you and your spouse can benefit, not the children.

    5. The returns on occupational pensions are fatally limited by the requirement of the pension trustees and investment managers to prioritise current pensioners, which means they tend to invest in poorly-performing bonds. With a SIPP, you can invest in whatever you like. So if, for example, you already have a perfectly-acceptable alternative sources of retirement income in the form of the State Pension, a rental property or five, and/or an intention to continue in part-time work after the official state retirement age, you are free to invest your SIPP during your working lifetime for long-term growth – in tech and biotech, if you wish, or private equity, or whatever – because you don’t actually need the income, and you are looking to the future to provide for your spouse and your children. If you leave your occupational pension chugging along at CPI rates of return, you are losing a massive opportunity cost with your capital.

    6. Occupational schemes can go bust. In a SIPP, your capital is your own, protected and tradeable on the global stock and bond markets. Yes, there can be market crashes, but they generally recover, and if you have to take a hit on your income for a while, so be it: most people will have taken similar hits during the rest of their lifetime, from redundancy to divorce to interest rates hitting 15%, and they have coped, by adjusting their behaviour, controlling their expenditure, and calling on other savings to get them through. And pensioners always have their state pensions to fall back on, which will make up the large part of most people’s needs if they have to batten down the hatches because their other sources of income have taken a temporary hit.

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