What is a stop loss? | OptionsANIMAL
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What is a stop loss?

Video Transcription

Hello again, Casey Jensen here at OptionsANIMAL. Now we’re discussing what a stop loss is? Stop losses can save you a lot of headaches and can save you some money. However, we never use them here at OptionsANIMAL. Now you might say why? Let me talk first off why a stop loss does make a lot of sense in theory. If you purchase a stock at, say 100, and you know you’re going on a vacation, or you work during the day, so you’re going to be busy for the next week, or so, so you don’t want to pay that much attention. That’s normal. So you put in a stop loss border to sell your stock at 95. Now, how this works; once the stock is trading at or below 95, it puts in an order to your broker to sell the stock, get rid of it, limit your loss in case the stop drops to 80 while you’re on vacation, you don’t want to go through that.

The problem: are we guaranteed to get filled at 95? The answer is no, unfortunately, you’re not. Stocks can gap down, they can end the trading day at 100 and open up the next day at 80, maybe because of a bad earnings report, you just never know, or the whole market could be crashing. So, that’s one of the problems with a stop loss; you can get filled at 80, you booked that loss at 80 and then the stock bounces right back up, quite frustrating.

Now, looking at it from another perspective; what if there were a different way that you could manage your risk? You can. You can buy a put option instead that gives you the absolute right to sell your stock at a fixed price. That’s one of the reasons you’ll never see us using a stop loss here at OptionsANIMAL. So, again, to remember with the stop loss, Warren Buffett I think said it best, he said, “My number one rule when it comes to investing is; don’t lose money.” Now, know when I first heard that I thought, “Come on Warren Buffett, thanks for pointing out the obvious.” Well, rule number two he says, “Refer to Rule number one.” Okay. It’s working for Warren Buffett; he’s worth a lot of money.

How do you do it? What I’m implying here folks is you do not have to book a loss at 80, there’s a better way to protect yourself. You can buy put options that give you the absolute right to sell a stock at a fixed price. In theory, this is going to make a lot of sense, the problem again: stocks gap, things happen, news events occur. You could be forced to sell your stock at 80, nobody wants to book that loss. That’s the problem with stop losses, you will book well too many loss. Look back to 2008 when stocks were gapping, it happens. So rather than do that we’re going to show you in future videos how to use that long put, in other words how to buy a put option as insurance now for your stock.

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