The business of investing in stocks is an inventory 'buying & selling' business. Naturally, the companies that sell stock to the public want you to buy and hold it forever in order to maintain its value. But, if you are buying without any selling, you are literally driving without any brakes. That is a horrifyingly unsafe position for your principal. The most effective defensive brake system for your money is a stop-loss order on your stocks.

A stop-loss order is an order you give your broker to sell your shares if a stock falls below a certain price. You can select a stop-loss price for your stock based upon chart patterns, or a percentage drop from your purchase price, and some brokers automatically move them as a stock moves up in price to lock in profits for you.

The first time I learned this lesson (not the last unfortunately), I was just 18 years old. One of my early stock purchases, a stockbroker from a famous brokerage firm recommended that I buy stock in a famous airline; just before it trailed off into bankruptcy. Had I read this article before the airlines’ financial calamity, I would have rescued most of my $5,000 and prevented my own financial calamity.

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Why Wait for the Stop

But you cry, “The greatest investor Warren Buffett is a buy & hold investor!” No, I’m afraid he is not. Mr. Buffett mainly buys whole companies or controlling interest in a company. He buys control so that if there are problems with the company, he can hire/fire/make changes. If there are critical problems with the company whose stock you own, the only control you have to protect your principal is to sell.

When a public company goes go bankrupt, 70% of the time, the shareholders receive no money at all. How many stocks do you want in your portfolio worth $0? I know exactly how many I that want, and I know that stop-loss orders prevent it from happening.

There are a few ‘loss-recovery’ methods, but you’ll never sell enough covered calls to recover from a stock trading under $5, or be able to buy puts on a stock that has been de-listed from an exchange. But the nearly certain protection is to place a stop-loss order on the stocks you own. You can choose any percentage loss amount (5%-25%) based on your experience, but you must have a stop-loss order in place to protect your capital.

There a zillions of old stock market sayings. Here is one of them for those of you who are still skeptical, “If the smart-money has sold and moved on, what type of money still own the stock?”

Francis Kier has two degrees in finance and shares his two decades of experience with investing and personal finance. More of his articles are available at http://investing.real-solution-center.com