But, Buffett doesn't use Stop Losses …

On my first Live Chat Show, in response to a viewer question, I discussed the theory of Stop Losses (I just posted on this, so I won’t go into the details here).

Andrew saw the show and asked:

Your webcast today prompted me to look up some more of Warren Buffet’s letters to shareholders and general advice, I wanted to get your take on something I came across that seemed potentially contrary to what you mentioned about your use of stop losses in your webcast today.

Warren said he believes that when you invest in a company you should be able to see it go down in value by as much as 50% and not sell off because you know that you already bought it at a steep value. I know this is potentially different than what you mentioned because you were talking about protecting gains, but if you have the time let me know what you think.

I’m amazed that my web-casts can prompt anybody to do anything! Well done, Andrew!

The way that I see it …

… there are two ways to invest: (a) buy and hold through thick and thin, (b) trade in/out on market swings.
Warren does (a) and I do (b) hence, Warren is (much, much, much) richer than me 😉
Warren’s method takes excellent understanding of the market fundamentals, a stock that provides strong underlying cash-flow, and a business model that will stand the test of time. It also takes an awful lot of faith …
Trading in/out seeks to avoid staying in a falling stock … those choosing this path, generally are trying to move with the ‘Big Boys’ (the institutional ‘insiders’ who might have caught wind of some negative news that may put a short-term dent in the company stock) or are trying to avoid getting caught up in a dog that looked like a show-pony.
(b) is also trying to time the market, and we know where that can go …
But, Warren and I agree on the underlying principle: we are both buying a stock that we believe is currently well-underpriced by the market, and one that we would be prepared to hold on to for a very long time.
I just trade in/out of the inevitable (and, hopefully, relatively small) up/down swings in what I hope is a generally upward trend … once the stock gets back to market price, I’m out’a there, Baby!
Who’s method works better over the long-term: Warren’s, without a doubt!
Remember, always go with the money 🙂
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2 thoughts on “But, Buffett doesn't use Stop Losses …

  1. I’m not sure that this really needs to be a black or white issue.

    I’m currently developing my own investment strategy and recently wrote an article about stop losses which I intend to start using though I haven’t decided exactly how yet. But broadly speaking, I only buy into a stock if it seems to have more than 100% upside with very limited risks. A Buffett like approach if you like. However, unless I’m absolutely certain of the intrinsic value and that the market will recognise it in due course, I think its worth setting a stop loss.

    The stop loss limits risk and protects gains and as a share price gets closer to the value I place on it, so the risks increase of a downturn in price. Therefore the stop loss will protect my gains and prevent me making the classic investor mistake of holding on for too long and watching those hard earned gains disappear!

  2. @ ‘experiment – For the record, I am in the ‘use stop losses to limit your downside’ camp 🙂 I tend to set mine as a trailing stop, 8% to 10% below the current trading price.

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