The whole subject of whether or not you should employ stop losses is one that divides a lot of people. Some people swear by them, whilst others will either begrudgingly use them or not bother using them at all. So should long-term investors employ a stop loss or not when investing in stocks?

Well in my opinion it all depends on what kind of stocks you like to invest in. For instance if you are a speculative investor who likes to invest in bombed out stocks that may potentially recover in years to come, then it’s probably best to take your chances without a stop loss. This is because even if a few of these companies went bust, you can still make excellent returns if you manage to find a few stocks that end up multi-bagging, ie where the share price goes up 2, 5 or 10+ times higher than the price you paid.

If, however, you like to invest in mid or large cap stocks, then I think it’s imperative you use a stop loss. The fact is that even the largest and most well-known of companies can see their share price plunge very quickly when the wider market starts to head downwards. Just look at the share price of many of the leading banks in recent years.

So because of this, you really do need to protect your capital by having some kind of stop loss in place. It’s always better to take a small loss and come back to fight another day than to keep holding on to to falling stocks in strong downward trends in the hope that they will eventually bounce back.

You don’t necessarily have to set stop losses with your broker for every stock you hold. I personally set mental stop losses of around 20% and will close out a trade myself if the price of one of my holdings ever falls this much. It’s actually very rare for one of my shares to fall this much because I try to buy high quality stocks at the bottom of a cycle, but on the rare occasions they do fall this much, I will always sell them because it often means there is something fundamentally wrong with the company, and therefore the stock price is likely to continue falling.

So to sum up, I would say that if you have a sizeable share portfolio and like to manage your own money, then you need to protect this capital by managing any losses that you may incur. If you don’t, then there is always the chance that a few of your holdings could fall 40 or 50%, for example, or even go bankrupt in extreme cases, destroying your share portfolio in the process. If you take a loss of 10, 15 or 20%, however, it’s a lot easier to bounce back. Plus of course you can always buy back into these stocks if they start to recover.

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