Why I don't use stops

Stop losses are essential for managing risk if you are a momentum or technical trader, but they do the complete opposite for value investing.

Fist, the concept of stops goes directly against what value investing. Keeping the fundamentals constant, a lower price means less risks in the market. Your stock is even further below the intrinsic value, so if anything you should be buying more.

Using stops will more than likely guarantee losses than limit them. The problem is that stocks are just volatile, and more than likely, your stop will be triggered at one point, usually at exactly the wrong time. You can try to get around this by setting a stop even lower level, but you just risks selling your stock at a lower price when there is even less risks.

Now, if the stock drops because of a change in long term fundamentals, then you should get out. If you realized that you are now holding a broken company, you are no longer investing based on value, but on hope.

The hardest part about value investing is discerning whether a drop of price is justified by the fundamentals or irrational market fear. The problem is that we are human, and these price declines affect our emotions and our judgment of the situation. When the market is giving you the sick feeling in your stomach, the only immediate remedy to stop the pain is to sell, which usually at the worst time possible.

One method that I like the best to fight this urge is to write down your justifications for your stock in advance. Stepping away from the stock price, and rereading why you bought the stock in the first place will help you find your bearings again. If your story for buying the stock remains the same, you can justify holding onto it. Putting down the risks and fundamental events that will justify you to sell your holdings will keep you more objective, so that you will know if it is alright to sell.

This is still easier said than done. As much as people try to fight it, we will always be affected by the herd psychology. However, preparing in advance for these situations in advance will still make it much easier to handle these tough times.

One last thing I wan to stress is that value investing is completely different than other types of trading. In value investing, you don't play the psychology of the market, so there is no need to protect yourself from it with stops. You have to have a different set of tools if you want to successfully make excess returns in the market.