A stop-loss order is an instruction you give to your broker to sell exchange-traded mutual funds once they hit a certain price below your initial investment. The order can spare you additional losses if the stocks are falling, but it also can result in losses much greater than you hoped for. The stop-loss order is a safety net that can be especially beneficial in a fast-moving market. At the same time, once the order is set, your broker must sell your shares, which could cause you to lose profits had your broker been able to ride out the dips.
1. Exchange your indexed mutual funds for exchange-traded funds. Traditional mutual funds take too long to sell because a trade can’t be executed until the fund’s net asset value is calculated. By the time that occurs, your lowest sell price may have passed. If markets are falling rapidly, you can’t react quickly enough. An exchange-traded fund, or ETF, trades like stock and is easier to control in a fast-moving market.
2. Follow your broker’s requirements for initiating the stop-loss order. Your broker may accept a verbal order over the phone or require you to fill out an order form that you have to sign. You may be able to include the stop-loss order when you first purchase the funds or add the order into an electronic order form that you file through the broker’s website.
3. Monitor the ETFs yourself so that you can enter a sell order when the funds reach your stop-loss point. This may be necessary if your broker won’t accept stop-loss orders. Set up an electronic monitoring service to automatically alert you when your ETFs reach a certain red-flag point, so that you can go in and manually issue the sell order.
4. Consolidate your ETFs into a few asset categories to make it easier to monitor changes. You pay a fee for each sell order, so when you have fewer mutual funds, you’ll have fewer fees to pay when you do initiate a stop-loss sale.
- Place a stop-loss order for no more than 25 percent of your initial investment to give yourself room for the normal ups and downs that occur in the market. For example, if you paid $100 for a share in an exchange-traded mutual fund, place the stop-loss order at $75. Once the value of your share increases, adjust your stop-loss order accordingly. So if your $100 share rises to $200, adjust your stop-loss order to $150 to keep it within the 25 percent range. Alternatively, you can place a trailing order with your broker in which the stop-loss price changes automatically as the price of your fund increases.
- It’s possible that your broker won’t accept stop-loss orders on your ETFs because they can interfere with the buy and sell fee structure inherent in mutual funds.
Items you will need
- Exchange-traded funds
- Written orders
- Electronic stock announcements
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