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Penny Stock Basics

Why I Don’t Use Stop-Loss Orders

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Written by Timothy Sykes
Updated 1/4/2023 13 min read

There’s a myth about stop-loss orders that could decimate your trading account.

For newbies, I’ve heard it called death by a thousand papercuts. Even if you study, learn my patterns, and play by the rules, this one mistake could cost you. Over time, you could churn and burn your account, never gaining traction.

Or you could take a loss so big it’s difficult to recover. All because you followed the advice to set a stop-loss whenever you enter a trade.

I don’t use stop-loss orders. Ever. They’re NOT the smartest way to lower your risk as a trader. Keep reading for a full explanation.

Before that, you should understand the insanity of the current market…

Why 2020 Is a Perfect Storm for Retail Brokers

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Retail trading went crazy in the first half of 2020. A lot of people in lockdown suddenly had more time on their hands. They were spending less and looking to make more. Some lost their jobs and had no choice but to find a new way to make money.

And when college and professional sports also shut down it was like the perfect storm.

Day trading replaced sports betting as one of America’s favorite pastimes. The number of new accounts alone is staggering. Millions found their way to trading…

  • In the second quarter of 2020, Charles Schwab added 552,000 new accounts.
  • E-Trade added 329,000 in the first quarter and 327,000 in the second quarter.
  • Robinhood has grown from one million users in 2016 to over 10 million today. The company added three million users in the first quarter of 2020.
  • Fidelity opened a record 1.2 million new accounts in the first quarter.

It’s cool so many people are getting into trading. What’s NOT cool? That so many are risking so much without getting an education first…

If you’re brand new to trading and penny stocks, read my FREE penny stock guide.

Millennials and the Robinhood ‘Easy’ Button

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It’s a simple formula. Find all the people who aren’t investing and make it easy. Robinhood figured out how to take it one dangerous step further.

Ironically, there are myths about millennials and finance. They don’t trust financial advisors. They’re overly confident in their own ability to invest wisely.” Actual data disputes those myths.

But one thing Robinhood got right is that millennials like games. And we can be impulsive. I don’t think that’s unique to my age group. But there are more outlets for impulsive behavior. And with the pandemic, a lot of people need an outlet.

So they created an app that can encourage impulse trading … degenerate gambler mentality. It can make investing seem easy. One tap on your smartphone screen and you’re in a trade. You even get an idea of which stocks are ‘trending’ when you log in.

Robinhood made it more enticing by adding rewards to the game. When you sign up for Robinhood and link your bank account, you get a ‘free’ stock.

What could possibly go wrong?

Robinhood claims to be democratizing investing and finance. But it created a situation where amateurs have access to complex financial instruments. Even those who stick to buying and selling stocks have little idea what they’re doing.

It’s all too easy — and ‘free.’ Just see what’s trending and hit buy…

Meanwhile, the company has to make money. So how does a ‘free’ broker like Robinhood make money from trades?

The Truth About Payment for Order Flow

the bottom line on support and resistance
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Payment for order flow (PFOF) isn’t new. It’s been happening for years with all major brokers. What is it?

When a retail trader puts in an order, the broker passes it along to a market maker. Market makers pay a tiny percentage per trade back to the broker. Again, nothing new. All brokers do it to some degree. It assures the trade gets executed.

Keep in mind that your broker should find the best possible execution for your trade. In 2019, Robinhood got fined for best execution violations. The company claims to have fixed the problem. I don’t know if they have. And I don’t care. I use these brokers. It’s not that I love them — they just suck the least for me.

So what’s the big deal? What does all this have to do with stop-loss orders? PFOF is Robinhood’s main revenue stream. So it’s not just about getting trades done fast. It’s about getting as many trades done as possible so the company makes money.

Why You Should Avoid Stop-Loss Orders

A common piece of advice you find on the internet and in investing books is to set stop-losses. In theory, it makes sense. Say you buy a stock at $3.15. You’ve learned rule #1: cut losses quickly. So you set a stop-loss order at roughly 5%, or $3.

Sounds good, right? If the stock drops to $3, your stop-loss order gets triggered and your broker sells. You lose but also lower your risk of bigger losses. In theory…

The Risks of Setting Stop-Loss Orders

There are risks with setting stop-loss orders. And it’s how Robinhood made $90 million in the first quarter selling their order flow.

Newbies Set Stop-Loss Orders in the Same Places

One big problem is that so many newbie traders set stop losses at big round numbers.

Using the previous example, if you set your stop-loss at $3, you’ve joined a lot of traders. Why do so many traders choose the same numbers? Because it’s easy. They look at the chart, see the closest round number, and set their stop-loss there. Who cares if a 5% drop from $3.15 is actually $2.9925?

Also, a lot of traders set their stops at or around obvious support levels. If the stock has strong support at $2.95, you might think, “Oh, everyone will set theirs at $3. I’ll set mine at $2.95. I’m smarter than them.”

Too bad most of the traders who didn’t set their stops at $3 followed your lead and set theirs at $2.95.

So what’s the big deal? I mean, so a bunch of traders with stop-losses get taken out at $3 and a bunch more get taken out at $2.95. Either way, you’ve protected yourself, right? WRONG!

Here’s why…

Market Makers Can See Your Stop-Loss Orders

Most newbies place stops that are visible to market makers. So market makers move the stock to the stop-loss levels and take them out. Especially during low volume trading in the middle of the day.

Why would they do that?

Everyone’s in it to make money. Everyone. But one reason is so they can keep shares moving.

Taking Out Stops Increases Market Liquidity

If there’s no volume, the stock price can’t move. And if the stock price isn’t moving and no one’s buying or selling shares, nobody’s making money. The stock market favors liquidity. Remember, most of Robinhood’s revenue comes from payment for order flow. So they need the trades to keep happening.

The market makers also need the trades to keep happening. Everyone needs trades to keep happening. So the market makers take out stops.

More Trades Means Higher Revenue From PFOF

What happens when Robinhood customers make more trades? Yep, Robinhood makes more money.

And right now, it’s pretty crazy. Between Robinhood, Charles Schwab, E-Trade, and Fidelity, we’ve seen an increase of at least 5.4 million new trading accounts. That’s a conservative number.

At the same time, brokers have announced a huge increase in the number of managed trades. Has this had a big impact on the market at large? Probably not. The cash flowing into the stock market is tiny compared to institutional investors. But that doesn’t matter…

The point is that more trades are happening. And since so many of them are happening on Robinhood, the company is banking on newbies.

Which leads me to…

Why I NEVER Use Stop-Loss Orders

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I want to be in control.

Let’s take the hypothetical example a step further. What triggers stop-loss orders?

The obvious answer is that the stock price drops to your stop level. But what if I told you the price doesn’t even have to drop there … Wait. What?

Check it out…

I’ve talked before about how traders paint the tape. They place a one-share order to make other traders believe the stock is moving to that price. Watch level 2 for about 10 minutes and you can see it.

With stop-loss orders, the stock doesn’t even need to sell at your stop level. If anyone offers the stock at your stop level and it becomes the ask, it triggers your stop-loss.

So if someone wants to take out stop-losses, all they need to do is paint the tape. Let that sink in…

So what if you set your stop at $2.95 because you knew everyone else would set at $3? Then the stock busts through $3 but a huge buyer comes in at $2.98. Your stop could still trigger if there’s an offer of a single share at $2.95.

Sadly, this happens often. The stock runs right back up and you got stopped out of what should’ve been a profitable trade.

Which explains…

Why Robinhood Can Be Dangerous

Most traders set stops that trigger market orders. Once it’s triggered, a market order to sell your shares enters the order book.

What if the stock is tanking?

Your stop gets triggered, so now it’s a market order. If a lot of stop losses go off at the same time, your order could get filled far from your stop-loss order. We’re not talking a little slippage. Instead of selling at $2.95, your order could fill at $2.75, $2.65 … or even $2.25 per share.

Slippage is part of trading. But you don’t want to get caught in a huge panic when stops get taken out. If you get caught, you NEED to be in control so you can find the best price to get out.

Check out this video on slippage…

Why The Heck Wasn’t My Order Filled? Slippage Can Cost You Money…

Like I said in the video, never use market orders. And when you’re in a trade, don’t think about how much money you’re going to make. Think in terms of capturing the meat of the move.

Here’s another video to further explain it…

Why You Should Never Use a Market Order

The point is … with stop-loss orders you think you’re in control, but you’re not. You think you’re safe, but you’re not.

Robinhood Preys on the Uneducated Amateur

Are there people making money using Robinhood? Probably. But I’d guess that long term, they won’t be able to grow their accounts. It’s too easy to trade and too much like a game. And Robinhood is banking when market makers take out stop-loss orders.

What’s the answer?

Educate Yourself

For me, it’s obvious. Trading doesn’t have to be hard, but you do have to be prepared. Robinhood has it all wrong … there’s no ‘Easy’ button.

This is a great place to start…

The stock market is a battlefield. You MUST prepare for battle. I want to be the mentor to you that I never had, but it’s up to you to take action today.

What to think of stop-loss orders after reading this post? Comment below, I love to hear from all my readers!

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Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”