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Real Questions from Real Subscribers

Q: What kind of stop orders should I use for my stocks? Do you prefer a 10% stop, or something tighter like 2% or 5%?

A: Dear Subscriber,

We're not fans of stop orders for several reasons.

1) Stocks as a whole are fairly volatile, rising and falling all the time along with the market. Stop orders have an annoying tendency to get people out just about the time the market turns higher. For this reason, if you do use stop orders, wider stops are less likely to bail you out of a quality stock at the wrong time.

2) If something truly bad happens, a stop won't always get you out at the price you want. A man who owns a $50 stock with a stop at $45 might be overly confident that he can only lose $5 on the shares. But if the stock opens at $40 on bad news that broke overnight, he won't get $45 for those shares.

3) Our research suggests that a policy of selling stocks after drops of 5%, 10%, and even 20% has tended to lag buy-and-hold strategies, at least with the high-quality stocks we tend to favor. Far too many stocks have fallen 10% or more on knee-jerk reactions to bad news, then bounced back strong.

Thanks for your interest,

Bob Sweet, CFA
Managing Editor, Dow Theory Forecasts

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