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Rookie Investor: Finding out the easy way the importance of a stop-loss

The Rookie Investors has still got the Fever(tree), but would he have done had he set a stop-loss?
Fevertree tonics
Losing your bottle? Try a stop-loss

If dear old Prudence is looking down on me now, she’d be one proud great-aunt. Not only have I spent her cash wisely (so far), but I’ve also managed to turn a little profit.

I’ve had a couple of scares recently though. Fevertree Drinks PLC (LON:FEVR) announced its full-years last Tuesday, which immediately sparked some big profit-taking.

Shares dropped more than 7% that morning, leaving me a teary-eyed and unapproachable wreck for a few hours. Kleenex would’ve perhaps been a wiser investment.

My grief was compounded when my editor chirped up and said a stop-loss would’ve limited my potential losses.

I’ve heard of stop-losses but generally cast them aside as a cop-out for the weak-minded. I never really considered them on the basis that if a stock quickly dropped but then picked up again, I’d have lost my position and likely a few quid too.

The logic behind a stop-loss is actually pretty sound though. None of us are going to get our investment decisions right all the time and so setting a stop-loss can protect you against you from a sharp drop in the share price.

Generally you pick a point and if the price crosses that level your broker will sell your shares immediately and at the best possible price. They’re a pretty useful failsafe if you’re unable to keep a close eye on your portfolio because of being on holiday or something, and they can stop you from getting a nasty surprise upon your return.

There’s no magic level at which you should set your stop-loss and a lot depends on your risk appetite with that particular investment. Set it too high and you might not have given the shares a real chance to perform, while if you set it too low and have picked a dud, you risk a heavier fall.

You normally set a stop-loss based on the initial buying price, say 10% below, but you can adjust this throughout so it can also be useful in crystallising profits.

Thankfully with Fevertree – which I don’t have a stop order on – the share price recovered on the Tuesday afternoon to test all-time highs. Had I put in place a stop-loss, my position might have been closed and I’d have missed out on the subsequent rise.

That’s what you might call learning the easy way and the initial emptiness I felt on that cold morning has given me an appreciation of a stop-loss and that it can play an important part in managing my portfolio.

BT Group PLC (LON:BT.A) has been through the mire again today and it’s probably set me back a little while in terms of when I sell now.

My original plan was to only hold the stock for a couple of months, which would’ve meant I’d be closing my position any day now.

Things had looked good only a couple of weeks ago when it posted a weekly close above 340p, but I might’ve missed the boat – at least for a little while.

It’s eased since then and lost another 2% or so this morning after it was fined a record £42mln by Ofcom and forced to set a further £300mln aside as compensation.

It’s back towards the 320p level at the moment, which is still a nice little profit, but not as much as I was hoping. Should the shares continue to ease then I’ll likely consider selling to make sure I walk out with some profit. That said, I’m still fairly confident that the telecoms giant will dust itself down (again) and pick up soon.

Thinking about it, BT might be a good one to set my first stop-loss on…

The other member of the Holy Trinity is AstraZeneca PLC (LON:AZN), which has been trundling along nicely recently and is up towards £50.

I mentioned last time out that I might consider selling this even before the results from the key MYSTIC lung cancer trial are out later this year, but to hell with that idea ‘cos I want it all, or nothing at all. There’s a song in that…

I received my first ever dividend last week courtesy of the drugs giant although I reinvested this immediately through the Dividend Reinvestment Plan (DRIP).

It’s pretty good actually. Most DRIPs allow shareholders to buy shares commission-free and sometimes even at a slight discount to the going market rate. It’s also an excellent way to increase the value of the investment so it’s something I’ll continue to use in other divi-paying stocks.

While the portfolio is hanging in there nicely at the moment, I’m still looking for my next investment. I’ve been thinking of investing in an oil or energy play for a little while now but as of yet I’ve not come to a decision.

There’ll likely be more on this in the next article, but in the meantime I’m open to suggestions; any ideas?

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