Using stop-loss as risk management: Is it safe?
A stop-loss does not guarantee a sale at the given price; it just automatically triggers an unlimited sale as soon as the market reaches the limit. Depending on the development, your sale could be right at, slightly under, or deeply under the stop-loss limit you gave - it could even be it is never executed, if there are no further deals. The point is that each sell needs a partner that buys for that price, and if nobody is buying, no sale happens, no matter what you do (automated or manually) - your stop loss cannot 'force' a sale. Stop-loss works well for minor corrections in liquid shares; it becomes less useful the less liquid a share is, and it will not be helpfull for seldomly traded shares. A stop-loss order becomes a market order when a trade has occurred at or below the trigger price you set when creating the order. This means that you could possibly end up selling some or all of your position at a price lower than your trigger price. For relatively illiquid securities your order may be split into transactions with several buyers at different prices and you could see a significant drop in price between the first part of the order and the last few shares. To mitigate this, brokers also offer a stop-limit order, where you set not only a trigger price, but also a minimum price that you are will to accept for your shares. This reduces the risk of selling at rock bottom prices, especially if you are selling a very large position. However, in the case of a flash crash where other sellers are driving the price below your limit, that part of your order may never execute and you could end up being stuck with a whole lot of shares that are worth less than both your stop loss trigger and limit price. For securities that are liquid and not very volatile, either option is a pretty safe way to cut your losses. For securities that are illiquid and/or very volatile a stop-limit order will prevent you from cashing out at bottom dollar and giving away a bargain to lurkers hanging out at the bottom of the market, but you may end up stuck with shares you don't want for longer than originally planned. It's up to you to decide which kind of risk you prefer.
"Eventually, you'll end up buying a stock at or near a high-water mark.  You might end up waiting a few years before you see your ""guaranteed"" $100 profit, and you now have $5K to $10K tied up in the wait.  The more frequently you trade, the faster your money gets trapped. There are two ways to avoid this problem: 1) Do it during strong bull markets.    If everything keeps going up you don't need to worry about peaks...but then why would you keep cashing out for $1 gains? 2) Accurately predict the peaks.    If you can see the future, why would you keep cashing out for $1 gains? Either way, this strategy will only make your broker happy, $8 at a time." "My gut is to say that any time there seems to be easy money to be made, the opportunity would fade as everyone jumped on it. Let me ask you - why do you think these stocks are priced to yield 7-9%? The DVY yields 3.41% as of Aug 30,'12.  The high yielding stocks you discovered may very well be hidden gems. Or they may need to reduce their dividends and subsequently drop in price.  No, it's not 'safe.' If the stocks you choose drop by 20%, you'd lose 40% of your money, if you made the purchase on 50% margin. There's risk with any stock purchase, one can claim no stock is safe. Either way, your proposal juices the effect to creating twice the risk.  Edit - After the conversation with Victor, let me add these thoughts. The ""Risk-Free"" rate is generally defined to be the 1yr tbill (and of course the risk of Gov default is not zero). There's the S&P 500 index which has a beta of 1 and is generally viewed as a decent index for comparison. You propose to use margin, so your risk, if done with an S&P index is twice that of the 1X S&P investor. However, you won't buy S&P but stocks with such a high yield I question their safety. You don't mention the stocks, so I can't quantify my answer, but it's tbill, S&P, 2X S&P, then you." "This doesn't make sense to me. Writing a covered call gives him a long delta position - the exact opposite of what he wants. And the tax losses won't turn a losing position into a winning one.  Is there something I'm missing?  Edit: Also, doesn't ""shorting against the box"" mean he has to have a long position, and short against that? That means you've got zero net delta, which isn't very useful at all..." "If you really believe in the particular stocks, then don't worry about their daily price.  Overall if the company is sound, and presumably paying a dividend, then you're in it for the long haul. Notwithstanding that, it is reasonable to look for a way out.  The two you describe are quite different in their specifics. Selling sounds like the simpler of the two, but the trigger event, and if it is automatic or ""manual"" matters.  If you are happy to put in a sell order at some time in the future, then just go ahead with that. Many brokers can place a STOP order, that will trigger on a certain price threshold being hit.  Do note, however, that by default this would place a market order, and depending on the price that breaks through, in the event of a flash crash, depending on how fast the brokers systems were, you could find yourself selling quite cheaply. A STOP LIMIT order will place a limit order at a triggered price.  This would limit your overall downside loss, but you might not sell at all if the market is really running away. Options are another reasonable way to deal with the situation, sort of like insurance.  In this case you would likely buy a PUT, which would give you the right, but not the obligation to sell the stock at the price the that was specified in the option.  In this case, no matter what, you are out the price of the option itself (hence my allusion to insurance), but if the event never happens then that was the price you paid to have that peace of mind. I cannot recommend a specific course of action, but hopefully that fleshed out the options you have." "This type of structured product is called a capital protection product.  It's like an insurance product - where you give up some upside for protection against losses in certain cases.   From the bank's perspective they take your investment, treat it as an ""interest-free loan"" and buy derivatives (like options) that give them an expected return greater then  They make their money: With this product, you are giving up some potential upside in order to protect against losses (other than catastrophic losses if the lower index drops by 50% or more).   What's the catch? There's not really a catch. It's a lot like insurance, you might come out ahead (e.g. if the market goes down less than 50%), but you might also give up some upside.  The bank will sell enough of these in various flavors to reduce their risk overall (losses in your product will be covered by gains in another). Note that this product won't necessarily sell for $1,000. You might have to pay $1,100 (or $1,005, or whatever the bank can get people to buy them for) for each note whenever it's released.  That's where the gain or loss comes into play.  If you pay $1,100 but only get $1,000 back because the index didn't go up (or went down) you'd have a net loss of $100. It's subtle, but it is in the prospectus: The estimated value of the notes is only an estimate determined by reference to several factors.  The original issue price of the notes will    exceed the estimated value of the notes because costs associated with selling, structuring and hedging the notes are included in the original issue price of the notes.  These costs include the selling commissions, the projected profits, if any, that our affiliates expect to realize for assuming risks inherent in hedging our obligations under the notes and the estimated cost of hedging our obligations under the notes." Great question! It can be a confusing for sure -- but here's a great example I've adapted to your scenario: As a Day Trader, you buy 100 shares of LMNO at $100, then after a large drop the same day, you sell all 10 shares at $90 for a loss of $1,000. Later in the afternoon, you bought another 100 shares at $92 and resold them an hour later at $97 (a $500 profit), closing out your position for the day. The second trade had a profit of $500, so you had a net loss of $500 (the $1,000 loss plus the $500 profit).  Here’s how this works out tax-wise: The IRS first disallows the $1,000 loss and lets you show only a profit of $500 for the first trade (since it was a wash). But it lets you add the $1,000 loss to the basis of your replacement shares. So instead of spending $9,200 (100 shares times $92), for tax purposes, you spent $10,200 ($9,200 plus $1,000), which means that the second trade is what caused you to lose the $500 that you added back (100 x $97 = $9,700 minus the 100 x $102 = $10,200, netting $500 loss). On a net basis, you get to record your loss, it just gets recorded on the second trade. The basis addition lets you work off your wash-sale losses eventually, and in your case, on Day 3 you would recognize a $500 final net loss for tax purposes since you EXITED your position. Caveat: UNLESS you re-enter LMNO within 30 days later (at which point it would be another wash and the basis would shift again). Source: http://www.dummies.com/personal-finance/investing/day-trading/understand-the-irs-wash-sale-rule-when-day-trading/ Stop order is shorter term for stop-loss order.  The point being that is intended as a protective measure.  A buy stop order would be used to limit losses when an investor has sold a stock short.  (Meaning that they have borrowed stock and sold it, in hopes that they can take advantage of a decline in the stock's price by replacing the borrowed stock later at a cheaper price.  The idea is to limit losses due to a rising stock price.)  Meanwhile, a sell stop order would be used to limit losses on a stock that an investor actually owns, by selling it before the price declines further. The important thing to keep in mind about stop orders is that they turn into market orders when the stop price is reached.  This means that they will be filled at the best available price when the order is actually executed.  In fast moving markets, this can be a price that is quite different from the stop price. A limit order allows an investor to ensure that they do not buy/sell a stock at more/less than the specified amount. The thing to keep in mind is that a limit order is not guaranteed to execute. A stop-limit order is a combination of a stop-loss order and limit order, in that it becomes a limit order (instead of a market order) when the stop price is reached. Links to definitions: Stop order Stop-limit order Limit order Market order "Your strategy fails to control risk. Your ""inversed crash"" is called a rally. And These kind of things often turn into bigger rallies because of short squeezes, when all the people that are shorting a stock are forced to close their stock because of margin calls - its not that shorts ""scramble"" to close their position, the broker AUTOMATICALLY closes your short positions with market orders and you are stuck with the loss. So no, your ""trick"" is not enough. There are better ways to profit from a bearish outlook." "Of course, which is why you need to have a scoring function / utility function for the ""filters"", i.e. Are you going to value it by rate of accuracy hor by a metric where wins = +2, losses = -1, such that it uses a criteria like that to decide whether or not a filter adds value, (some even use a compound effect i.e. wins = 2+e^(1+w) where w is the consecutive wins).  A metric like the above would capture the trade off between predictive power and profit. Also some traders watch their Max DD very carefully so they may be very risk averse." "Yes.  I heard back from a couple brokerages that gave detailed responses. Specifically: In a Margin account, there are no SEC trade settlement rules, which means there is no risk of any free ride violations. The SEC has a FAQ page on free-riding, which states that it applies specifically to cash accounts. This led me to dig up the text on Regulation T which gives the ""free-riding"" rule in §220.8(c), which is titled ""90 day freeze"". §220.8 is the section on cash accounts. Nothing in the sections on margin accounts mentions such a settlement restriction. From the Wikipedia page on Free Riding, the margin agreement implicitly covers settlement. ""Buying Power"" doesn't seem to be a Regulation T thing, but it's something that the brokerages that I've seen use to state how much purchasing power a client has. Given the response from the brokerage, above, and my reading of Regulation T and the relevant Wikipedia page, proceeds from the sale of any security in a margin account are available immediately for reinvestment. Settlement is covered implicitly by margin; i.e. it doesn't detract from buying power. Additionally, I have personally been making these types of trades over the last year. In a sub-$25K margin account, proceeds are immediately available. The only thing I still have to look out for is running into the day-trading rules." I would be using stop limit orders for stocks that are not too volatile. If you look at the chart and there are not many gaps especially after peaks, then you have more chance of being filled at your specified stop loss level using a stop limit order. If the stock is very volatile and has a large or many gaps down after most peak, then I would consider using a stop market order to make sure you do get out even if it is somewhat past your desired stop level. One think to consider is to avoid trading very volatile stocks that gap often. This is what I do, and using stop limit orders my stop level is achieved more than 95% of the time. If you plan to take profit at $1.00 then your profit will be $40. Then, if you set your stop at $0.88 then your loss if you get stopped will be $20.  So your Reward : Risk = 2:1.  Note, that this does not take into account brokerage in and out and any slippage from the price gapping past your stop loss. If the position starts losing money as soon as it is put on, then I would close it out ,taking a small loss. However, if it starts making money,as in the stock inches higher, then you can use part of the premium collected to buy an out of money put, thereby limiting your downside. It is called a collar. The strategy could conceivably work if you had sufficient quantity of shares to fill all of the outstanding buy orders and fill your lower buy orders.  But in this case you are forcing the market down by selling and reinforcing the notion that there is a sell off by filling ever lower buy orders.  There is the potential to trigger some stop loss orders if you can pressure it low enough.  There is a lot of risk here that someone sees what you are doing and decides to jump in and buy forcing the price back up.  Could this work sure.  But it is very risky and if you fail to create the panic selling then you risk losing big.  I also suspect that this would violate SEC Rules and several laws.  And if the price drops too far then trading on the stock would be halted and is likely to return at the appropriate price. Bottom line I can not see a scenario where you do not trigger the stop, net a profit and end up with as many or more stock that you had in the first place. In case you didn't see over the past few years, especially in banks, falling stock prices often lead to ratings downgrades. The logic is that a bank who's stock price is low, or falling, is suffering from a decrease in their ability to tap the equity markets in times of need.  With less ability to tap the equity markets in times of need, this means it is less likely the bank can raise funds to pay off debt, and thus, makes their debt more risky.   It's unfair for me to imply a 100% causal relationship here, because that's not the case, but each of the markets interact with each other in some way. You will at least notice that, whether leading or trailing, companies that have a decreasing stock price also often have a decreasing credit rating.  You'll also notice that stocks which slip under $5 often times get put on credit watch.   The logic could go any which way around the circle, but a company that cuts its dividend may lose some investors who were in it for the dividend. This can cause stock price to fall. Credit agencies, depending on the situation, may approve of companies that cut their dividend (more cash to pay off debt), or, may indicate the dividend cut is not enough to make up for the company's falling profits.   In the absence of full information, a cut in the dividend is often seen as a sign of weakness or a sign of tough times for the company in the future. Companies which have changes in dividend are looked at as less stable, more unpredictable, blah blah blah.   Again, I'm not implying a 100% causal relationship here, but, each of these markets work with each other somehow, and a bank which cuts its dividend may be expecting lower profitability, slower growth, need the funds to cover lawsuit payouts or settlements with insert-regulatory-agency, or any number of other situations.