Ask Colin

If a stock goes ex-dividend, do you give some tolerance to its stop loss point?

The short answer to this question is no. However, I need to explain why the answer is no.

A stop-loss point is defined in my mind as the price level which, if the stock fell through it, I am wrong about the investment. So, if my stop-loss level is violated I sell without hesitation, because the investment has failed.

This sounds easy, but it is far from simple. I have made it simple because I have a very clear concept of what I am trying to do in my investing. I am trying to capture an uptrend. I build a position into a developing uptrend. An uptrend requires that each trough is higher than the last one. So, my investment has failed if the trend fails. The trend has failed if a correction falls lower than the previous correction. So, you can see that the stop-loss method I use is a logical outgrowth of the investment plan itself.

A good trend will extend over several years and there will be two dividends a year. Good trends are rarely ended by a dividend payment causing an unusual drop in price. If it does occasionally, it does not worry me. That is the nature of investing. If the trend reasserts itself later, I can always buy it back. However, as I said I this is a very rare situation. I can’t remember the last one.

Many people do not have a clear idea of what they are trying to do. Also, it follows that their stop-loss level may be unconnected logically with the objective of their investment. Mostly it is quite arbitrary. This is not conducive to sound investing.

The reason that I have no trouble with my stop-loss levels is that I define the first one before I put on the order. Indeed, I need to define it in order to measure my risk and calculate the initial position size. I then have clear rules for how I move the stop-loss level up as the trend unfolds. I will always have that stop-loss level decided and marked on the chart before the price action happens that triggers it.

There are two exceptions to this. I have two sell-stops that can be higher than my stop-loss level. These are alternative ways the trend can fail before it falls to my stop-loss level. I also mark these on my chart before the price action happens.

So, it really is easy. I decide where I am wrong and mark it on the chart well before it happens. Then if the price falls through one of the levels, I sell without having to think about it. I feel good about that, even if it is a losing investment. The only time I would feel bad is if I hesitated and did not execute my stop-loss. I don’t like to feel bad, so I always execute the stop-loss immediately – the easy way out.