As an investor, it’s essential to understand that risk assets come with no guaranteed returns. Setting and following a stop loss can help protect your capital from significant losses, especially if you're an active investor who picks individual stocks.
Yet, I've come to realize that stop losses aren't only useful for active investors—they can be applied to many other aspects of life as well.
If you're a long-term, passive index investor, you might not need a stop loss, as broad stock indexes aren't likely to go to zero. Instead, you should probably dollar-cost average during sell-offs.
Let's break down the concept of a stop loss, explore a couple of examples with investing and poker, and finally, look at how stop losses can enhance other areas of life.
What Is a Stop Loss?
A stop-loss is a broker-placed order to sell a security once it hits a specified price, primarily to limit potential losses. For example, if you purchase a stock at $50 and set a stop loss at $40, your shares will be automatically sold if the stock drops to $40, preventing further loss.
The stop loss reflects the humility to recognize when your investment thesis is flawed. It takes discipline to accept your error and sell before losses deepen.
Value Traps and Stop Losses
If you're a value investor, a stop loss can be particularly valuable. You’re often drawn to stocks that have corrected, believing the company isn't fundamentally broken and that management will eventually turn things around.
But stocks often correct for a reason. When you’re buying into negative momentum, the stock can continue to slide, resulting in a “value trap.” Even if the price seems low, earnings could be permanently compromised, making the valuation higher than it appears.
IBM was a classic value trap from 2014 through 2023. Similarly, AT&T has been a laggard since the global financial crisis. While AT&T at least paid a high dividend yield, it’s still been a lackluster performer.
Is Nike a Value Trap?
I allocate around 30% of my cash flow to individual stocks, aiming to find S&P 500 index outperformers that will accelerate wealth creation. Having spent 13 years in equities and living in San Francisco, I can’t resist the appeal of individual stock investing.
After all, almost everyone I know who achieved extraordinary wealth did so through investments beyond index funds. But there’s a catch—most active fund managers still struggle to outperform the index. It’s a tricky balance.
As a new investor in Nike in July 2024, buying in the low-$70 range, I wonder if I'm making a mistake. At the time of this post, the stock is down about 11% over the five-year span from October 2019 to October 2024—a disappointing performance.
Still, I’m buying because:
- I love Nike’s products since 12
- There's a new CEO
- They’re reclaiming retail space and enhancing online buying experiences
- New technology and more affordable products are on the horizon
- Their NBA contract was renewed
- They have potential to move into pickleball, the world’s fastest-growing sport
Historically, Nike’s 10-year average price-to-earnings (P/E) ratio is 36.29. Currently, it’s 22.46, which is about 38% lower than the historical average—not cheap, but at least relatively discounted. At its peak in November 2020, Nike’s P/E ratio hit 74.42, with a share price of $134.7 and earnings of $1.81.
Because Nike could still be a value trap, I’ve set a stop loss for half of my shares at $70. If Nike breaks this level, it could signal further declines or a prolonged period of “dead money.”
My stop loss not only limits my downside but also minimizes the opportunity cost of potentially missing out on other investments. If the S&P 500 bull market continues, holding Nike instead of an index fund would amplify my losses.
Using Stop Losses in Poker
Beyond applying stop losses in investing, you can also use them in poker to limit your downside.
In a previous post, I mentioned sometimes feeling overwhelmed in semi-retirement with so many activities in limited time. This was exactly the case when I went to a friend’s house for poker after putting the kids to bed by 8:45 pm on Saturday. Since I had pickleball at 7 am the next day, I planned to leave by 1:30 am to get at least five hours of sleep.
My two poker stop losses were losing no more than $300 and leaving no later than 1:30 am.
Among my poker friends, I’m known as a tight player—an image I’ve cultivated to bluff more effectively. In reality, I’m an aggressive player who bets big when probabilities are in my favor. If you play against me, you better be ready to risk your entire stack.
Putting Pressure on My Opponent
At 1 am, sitting in the big blind, I looked down at pocket threes. A decent pre-flop but mediocre hand post-flop.
The blinds were $0.50/$1.00, and after a $5 raise and a call, D—the maniac on the button—raised to $18. I decided to re-raise him to $100, leaving me with just $40 left, hoping to take down the pot for a $28 gain. The $5 raiser and caller folded, but Dan deliberated, then put me all in for $140.
Given I was pot committed and still thought I was ahead, I called, assuming he held overcards like Ace-King and was a slight underdog.
The Coin Flip: Playing the Probabilities
Pocket threes versus Ace-King is a classic “coin flip.” My pocket threes had a slight edge:
- Pocket Threes: ~52.5%
- Ace-King: ~47.5%
With pocket threes, I had a slight advantage as they’re already a made hand, while Ace-King is still looking to connect with the board.
Instead of showing Ace-King, D showed Ace-8 of diamonds—a weaker hand but true to his maniacal style.
The Flop Comes
While the hand unfolded, I went to the bathroom, telling the dealer to proceed. But the dealer purposefully waited for me to heighten the drama.
Once I returned, he dealt the flop: 4, 10, 5, putting me in the lead with a 74% chance of winning. But on the turn, an 8 crushed my hopes as D’s Ace-8 paired up, leaving me with only a 5% chance to win unless I hit a 3 on the river.
A Poker Stop Loss Offer
Feeling defeated, I was suddenly offered a stop loss by D. He offered to split the pot 75%/25% in his favor. Since 25% was better than my 5% chance of winning, I took back $75 while D kept $225. What a gift!
Feeling relieved about losing just $65 instead of $140, I watched the dealer rabbit-hunt the river—a 3! Ugh. I would’ve won the entire $300 pot if he’d just dealt it out while I was taking a piss.
In poker, like investing, stop losses can sometimes backfire. It’s like selling Meta shares at $200 in 2022 after their peak of $376 in 2021, only to watch the stock soar past $570 later.
Overriding My Stop Loss for When to Go Home
I intended to leave at 1:30 am, but stubbornly stayed, determined to recoup my losses. Two hours later, at 3:00 am, I finally busted D and left as the big stack of the night. I paid for my stubbornness with only three hours of sleep before pickleball and needed a couple of days to catch up.
Fortunately, I had worked ahead and scheduled my newsletter for 4:30 am Sunday. Even with a stop loss in place, you might still ignore it out of sheer stubbornness.
Using Stop Losses To Improve Your Life
Now that I've shared a few financial applications for stop losses, let’s look at how we can apply the concept to enhance different areas of life.
Stop Losses with Friends: You might set a limit of five insults from a friend. After that fifth insult, you walk away from the relationship and focus on healthier connections.
Stop Losses in Career Growth: You could establish a limit of two missed promotions. If you’re passed over twice, it’s time to update your resume and explore new opportunities.
Stop Losses with Prospective Clients: Set a limit of three unanswered follow-ups with a prospective client. After the third attempt with no response, move on to other potential clients.
Stop Losses in Recreational Sports: Maybe you set a stop loss of two losses in the #1 doubles position. After the second loss, you and your partner shift to #2 doubles. Or in a baseball game, after two errors at third base, you switch to second base.
Stop Losses with Family Planning: For couples struggling to conceive, you might set a stop loss of three IVF cycles at $20,000 each. If unsuccessful, you shift to other options, such as adoption or getting a dog, to protect your finances, mental well-being, and physical health.
Stop Losses in Growing a Business: Set a time limit of three years to become profitable. If the business isn’t generating profit by then, you may consider getting a steady job to safeguard your financial stability.
Stubbornness and Delusion: The Enemies of Progress
One of the biggest risks in both investing and life is stubbornness and delusion. We sometimes convince ourselves that we know more than we really do. Despite a history of underperforming returns, active investors might still believe they can beat the market.
As we pursue financial independence, it’s critical to recognize our own limitations. If your active returns are consistently weak, stop picking individual stocks. Instead, invest in index funds and achieve growth steadily.
This same principle applies to personal choices. Stubbornness and delusion can cause us to hold on to toxic relationships or chase unfeasible goals, rather than moving forward with clarity. Embracing reality and taking calculated steps to adjust is key.
The Benefit of Accepting What You Don’t Know
Since we can’t predict every factor in risky investments, setting a stop loss can help manage our blind spots and protect us from ourselves. Key points of stop losses include:
- Automatic Execution: The set price triggers a market order, executing the sale at the best available price.
- Risk Management: It allows for downside protection without needing constant monitoring.
- Flexibility: Stop-loss orders are adjustable and useful in volatile markets for locking in profits or minimizing losses.
As you build more wealth, a primary rule for financial independence is to avoid catastrophic losses. Large losses not only affect your capital but can cost you something even more valuable: time.
It takes a 100% gain to recover from a 50% loss but only an 11.2% gain to recover from a 10% loss. With stop losses, you’re better protected and can ensure you’re consistently moving forward.
Openly Seek The Opinions Of Others
The easiest way to avoid ever saying, “If I knew then what I know now,” is by seeking the opinions of those who've been in your shoes. We all have blind spots that could benefit from outside insight, which is why I enjoy reading the perspectives of Financial Samurai readers.
In early 2013, even with 13 years of experience in equities, I sensed something was off with my investments. I’d left my job just eight months earlier, and although I was careful, I was still playing it too safe—52% of my net worth sat in cash. Speaking to a financial professional helped me understand I could take on more risk while still being smart about it. That conversation added over $1 million to my net worth over the next 11 years.
In today's bull market, many of you might feel invincible with portfolios riding high. Maybe you're even starting to feel like an investing genius. But it’s during these times of overconfidence that an objective review is invaluable.
Consider asking your partner, a knowledgeable friend, or a professional to review your net worth and investments—just as you’d get a second opinion before surgery. If the market turns, you’ll be better prepared. While those who’ve ignored the risks may find themselves caught off-guard with few ways to recover.
Diversify Your Retirement Investments
Stocks and bonds are classic staples for retirement investing. However, I also suggest diversifying into real estate—an investment that combines the income stability of bonds with greater upside potential.
Consider Fundrise, a platform that allows you to 100% passively invest in residential and industrial real estate. With over $3 billion in private real estate assets under management, Fundrise focuses on properties in the Sunbelt region, where valuations are lower, and yields tend to be higher. As the Federal Reserve embarks on a multi-year interest rate cut cycle, real estate demand is poised to grow in the coming years.
I’ve personally invested over $270,000 with Fundrise, and they’ve been a trusted partner and long-time sponsor of Financial Samurai. With a $10 investment minimum, diversifying your portfolio has never been easier.
To expedite your journey to financial freedom, join over 60,000 others and subscribe to the free Financial Samurai newsletter. Financial Samurai is among the largest independently-owned personal finance websites, established in 2009.
Yes stop-losses can be useful in lots of ways. I have gravitated more to a style where I do not use stop losses that much but I do size the position to a level such that I am almost comfortable with a full loss worst case scenario! Bu then I don’t use leverage (except with options) diversify extensively among asset classes (Individual equities, funds, ETFS,bonds, cash, currencies and commodities, even crypto!) and try and time my buys at a level which I am comfortable ie buy low.
As someone mentioned above – I think options can be very useful as a replacement for a stop loss and also a way of mitigating downside risk. As a speculative tool I have found being long options to be a very good way of participating on the upside of moves while keeping a strict handle on closed equity drawdowns. Being long stocks also has a similar risk profile with theoretically unlimited upside and strictly controlled downside.
One of the problems with stop losses being in the market is stops getting hunted, and whipsaws – options can mitigate these issues. Of course, there is a cost to be paid, in terms of premium.
Here’s a comparison to consider: should we go with a protective put for downside protection, or stick with a stop-loss order?
With a protective put, you buy stock and a put option at the same strike price, which limits potential losses if the stock drops but also allows for unlimited profit if it rises. For instance, if you buy 100 shares of XYZ at $100 and add a put at a 100 strike price for $3.25, your maximum risk is capped at $3.25 per share plus any commissions. This approach provides clear protection until the put’s expiration but, of course, comes at the cost of the put premium.
On the other hand, a stop-loss order sells the stock if it falls to a set price, so you avoid paying for the put option but don’t have guaranteed protection if the stock gaps down below the stop-loss price.
Would a protective put offer more certainty in volatile markets compared to a stop-loss? Do the costs of the put justify the level of security it provides, or does the simplicity of a stop-loss make more sense overall? Would love to hear others’ thoughts on the trade-offs between these strategies!
Yes, my understanding is that given Sam’s example, you bought at $50 with a stop at $40… but you may end up selling at some price far south of $40… maybe $20, or even $10… levels at which you may have decided to just wait to see what happens. An hour or two later, the price could be back up to $45,but your stock was gone at $10.
Maya Angelou – “When someone shows you who they are, believe them the first time.”
I had a friend once who kept on being an a hole to me. He was condescending and always treated me poorly. The first time I was shocked. The second time I brushed it off. But after the third time, and when someone pointed out his mistreatment, I knew I just had to get out of the toxic relationship.
Even his mother doesn’t want to communicate with him. He is that much of an ass.
Using a stop loss for getting rid of toxic friends is spot on.
not to turn this into a poker blog, but 1) once you turn over 33 after the 4 bet, it’s likely that anyone paying attention knows you are not overly tight. 2) your 4 bet is too big. Since you leave yourself no fold equity, you should have just jammed, or you could have made it $60 and not pot committed yourself to a flip at best, because even if he is a maniac, its not like he is doing that with 59off or J2. if he is reraising you with 60% of hands (which is a maniac-like range) you are pretty much 50/50. if you have a skill edge in that game, there is no reason to take that flip unless you just want to gambool
I think you missed the part where he re-raised me all in for $140 pre-flop after I bet $100. So that was an easy call by me.
I already felt that he had two over cards, but didn’t have a quality hand.
All night, he was betting erratically and aggressively. In the end, I busted him up in three hands and turned his $421 to $0.
At the turn, would you not have taken the 25/75 pot split with your pocket 3s facing an A8 and pairing up the 8? If not, why not?
And yes, 4 bedding to $100 pre-flop is aggressive.. But everybody I play against still thinks I am super tight based on the way I talk as well as the number of hands I play. It’s all gamesmanship!
I didn’t miss that part. I would not have raised to $100 off his $18 raise. 33 is too hard to play out of position correctly unless you flop a set, even when you rightly suspect he is “light”. I will say that his raise from the button with A8dd is absolutely the GTO correct play. That is a very strong hand relative to others.
Now, Using GTO ranges, you were right not to just call the raise (obviously you need to be getting ~8/1 for it to be a profitable call assuming he will stack off to you those times you do make a set).
Once you make it $100 and he raises you all in effective, of course its a snap call for $40 more, so that was correct. I also would have snap taken the buy out with 1 card to come. I guess if you were going to call the jam, you could have just jammed yourself instead of raising to $100, as you wouldn’t have had to face the (easy) decision. And I understand gamesmanship. But my point is there are better hands to do that with where you are not flipping at best. You want removal to the cards you think he might have (i.e. if you have an A there, its harder for him to have an ace for example).
Sounds good. But that’s what happened, a pre-raise of $100 to take down the money pre-flop. So you have to go with that fact to then start critiquing what I did wrong.
What is your poker background? That would be cool to get in a game with you as well.
And you use stop losses as well?
Well, I critique the whole hand…lol! Anyway, I’m a serious recreational player mostly cash games between $2/5 and 5/10 or 10/10. I’ve played a bunch of tournies as well cashing in a $1500 WSOP event this summer. I’ve played the main event 2x but not cashed. I’d be excited to play in a game with you.
As for stop losses, no. I don’t use them. I go to the poker room with 3-4 full buy ins in my pocket fully prepared to lose it all if I I think I’m a favorite in the game. Conversely, if I’m not playing well or if I don’t think I have a skill edge, I’ll get up. I also don’t have a stop win. Similar rules apply-if i think I have an edge, I’ll play until I need to leave. I have an hour drive home from my typical poker room, so I’m sometimes
Limited by that knowing when I leave I’ll
Have a decent drive, often at night. So also no drinking when I play. I will drink when I play in Vegas but usually in a lower stakes game.
Cool you played at the World Series of poker twice. How much of it do you think is luck, getting to the money? $10,000 buy in is a lot.
So back to my hand, if you were me with pocket threes, and my opponent hits his eight on the turn, would you not accept conceding and taking 25% of the pot?
Hi Sam – Out of curiosity and adjacent to one of the article’s sections, have you done a true/honest assessment of your personal long-term stock picking vs. the Nasdaq or S&P total return performance…? Outside of my gambler brain itch, I many times wonder how much better served my household would be over 10+ years averages if I just did 100% basic index allocations full time instead of ~75% because I think I am gonna “figure something out” by stock picking. PS, we have similar IB equities backgrounds…
I have held Google, Apple, QQQ for 12+ years, as well as a bunch of other stocks like Tesla for 7 years. So because of these overweight weightings, my rollover IRA (ex 401k) has outperformed the index by about 3% a year. It’s not huge, but it adds up.
The question now is, what’s next? So I’m looking for laggard plays, including small cap stocks, and the other 493 components of the S&P 500.
I should probably rebalance more to the S&P 500 index.
How about you?
Deciding the stop loss percentage is always my issue, not whether to use them. How did you decide on $70 (11.75%)? I set what I thought was a high stop loss before and then regretted the sale when I saw the reason for the drop, and then tried to get back in.
An estimated valuation, and a look at the stock support level. If Nike is going to break $70 a share after all the changes and the bad results, then there is something worse happening in the company that I am not seeing.
But I could always override the stop loss and just telecast average down as well.
Due to my investment style, I haven’t technically used stop losses. But I have looked at losing positions when I needed to sell positions to raise cash. I tried to calculate my gains and losses as I sold shares to maximize the IRS annual $3,000 deductible stock loss amount. But I ended up being way off because I didn’t look at my losses by each tax lot in detail. I instead relied on my broker’s average calc across all lots, which was way off from the way my shares actually were liquidated as FIFO. Lesson learned.
I like how you talk about applying stop losses to life as well. I’ve done this for some relationships and work. Toxic relationships, whether with friends or family, can be really hard to walk away from. But in these instances, we have to prioritize our own mental health when negative cycles can’t be broken.