When you should ditch trailing stop losses

Julie Brownlee, Fsp Invest, 24 Mar. 2014

Tags: trailing stop losses, stop loss, trailing stop, trailing stop loss, investment strategy, investing, invest, strategies, strategy, investor, reinvest dividends, dividends, shares, stocks, reinvesting dividends, compounding,

Each time you invest in a share, you should have an exit strategy in place, such as a trailing stop loss. This is good money management and should save you from large losses in your portfolio. But what about if you’re reinvesting your dividend payments to buy more shares for your retirement? Do you still apply your trailing stop loss even though a company’s share price may have fallen, but is still paying a good dividend? Read on to find out what you should do…

How a trailing stop loss works

A good exit strategy is a trailing stop loss, says Marc Lichtenfeld in Investment U. You place a stop loss 25% below your entry price. And as the share price rises, so does the stop loss.

A strategy like this can really protect you from horrific losses.

But there are exceptions…

If you’re a long-term investor who doesn’t need your dividend income at the moment. Instead you reinvest your dividend payments to buy more of the same shares.

By reinvesting your dividends, you automatically end up buying more shares with the payments.

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Falling share prices mean your dividends buy more shares

And if you are following a strategy like this, it doesn’t make sense to use trailing stop losses. That’s because a bear market makes shares cheaper. And this means you can buy more shares with your dividend payments.

When share values fall, it means even more compounding takes place. Compounding is a very powerful tool. The more shares you own, the more powerful compounding can be.

But this is a long-term strategy. So if you’re reinvesting your dividends, you need to ride out any bear markets.

As long as the companies you own shares in are still generating decent free flow and keep increasing their dividends, hold on.

With this strategy, the only time you should consider using stop losses is if you’re getting close to retirement and needing the cash. Or sell your shares and take the money out of the stock market.

So there you have it, when you should ditch trailing stop losses.

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