David Stevenson: Shareholders left shaken by ‘stop loss’ trades

Afew weeks ago, my column about the use of stop losses  on dealing accounts provoked a fascinating e-mail from a reader, expressing concern that private investors were ending up on the wrong end of these automated trades.

Stop losses are supposed to protect clients from falling share prices, by closing out their trades if a price hits a specified level. But I have since received a deluge of e-mails from readers giving some very specific examples of unusual activity.

Take, for example, the case of Alan. “Towards the end of 2006, I bought shares in EasyJet at a little under 600p a share. Over the next few months, they climbed to the mid-600s. I placed a rolling stop loss on the holding, so that the stop loss level was set at 20p less than the previous day’s close whenever it was higher than the close the day before. On January 9 2007, the closing price was 647.50p, so the stop loss was set at 628p. On January 10 it closed lower, so the stop loss remained unchanged. On January 11, the price opened at 642p, moved within a low/high range of 633p/649.5p, and closed at 647.5p. – ie the price apparently never fell to 628p. But I was dismayed to find that a sale had been triggered at 626.50p.”

Alan’s complaints to his broker got nowhere: the broker sent out a copy of the Stock Exchange Daily Official List, which purported to show that there was a short-lived dip to 626.50p. But every analysis tool showed that the day’s low was, emphatically, 633p. Alan says: “I cannot imagine ever using an automated stop loss again. I would advise fellow investors to be equally cautious.”

Then there is Philip, who runs a successful share club in south London. He cites trading in shares of a company called Globo on August 24 2009 – in particular, a specific line of 150,000 shares “going through at 11.15am at a price very different to the surrounding trades and not registering on the daily graph at all”.

A cursory look at the trade reveals an executed price well below the market activity for that day, although the broker concerned emphatically denies that the trade went through at below the market level.

Similarly, Robert reports suspicions that his broker “tends to execute these [stop losses] right at the start of the trading day during a dramatic oscillation of the stock price which quickly resumes its previous level. In the most recent case, this reduced a notional £1,250 profit to an actual £750 one.” Robert has complained vigorously but his broker insists that “the sudden short-term 5 per cent variation in the price was completely legitimate”.

Another reader, John, echoes these concerns: “I have been astonished at the frequency with which [the automatic stop losses] have been hit – only then for the price to continue rising”. He adds that he always selects the option not to publicly display his order on the order book. The times of the day for his trades? “Very early in the morning or last thing before closing.”

So what is going on? These investors seem to suspect that marketmakers and brokers who want to acquire certain stocks will briefly move the market price to allow the execution of their stop losses. As one investor put it: “They are therefore treating the stop loss as a declaration that you are prepared to trade at a lower price – rather than as a provisional order that you want to sell should the market genuinely drop to this price.”

Rachel reminds me that these market movements are called “tree shakes”. She says: “I [noticed] that the markets seem to deliberately aim at knocking these ‘tree shakes’.”

According to Will, tree shaking is “a very common occurrence”, although he questions how brokers can know about the stop losses unless they can see them on the order book. “If they cannot, then it’s just guesswork on their part and we investors should be a bit more clever in choosing our stops.”

All the brokers I’ve talked to emphatically deny tree shaking, saying there is no way in which they can piece together an individual’s stated intent with a market desire to increase liquidity at the lower price.

But, given the responses I’ve had, I’m not convinced. I’d now be very careful about setting an automated stop loss. I’d rather set up alerts with a share monitoring service, and trade manually.

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I’d like to canvass more shareholder opinions: this time on dividend reinvestment. Using cash dividends to buy more shares is one of the most important principles of long-term investing. Study after study has shown that reinvesting dividends accounts for between 60 and 95 per cent of total shareholder return. Many big FTSE 100 companies try to make it easy by running cheap dividend reinvestment schemes, known as Drips. But, sadly, these services are only available for certificated investors, not those that use their brokers’ nominee acounts. This forces most investors to rely on their brokers to automate the process. But they make it difficult and costly. My broker will reinvest but only after charging £10 per transaction unless the dividend is more than £200 – which prices out most of its customers! So I’m interested in hearing your experiences. Do you reinvest dividends? You can let me know by voting online at www.ft.com/adventurousinvestor . You’ll find a simple Yes/No poll on whether you do reinvest those dividends!

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