Stop-losses can be an enticing tool for investors looking for downside protection. But Validea CEO John Reese says that, if not used properly, they can wreak havoc on your portfolio.

“The great challenge [with value investing] is that cheap stocks can get cheaper in the short term,” Reese writes in his latest column for Canada’s Globe and Mail. “The fact that a good stock is a bargain at $20 a share doesn’t mean that it won’t fall to $15 or $10 before it rebounds, as more and more fearful investors bail. Because people’s emotions are in play, not even the smartest investors are able to reliably predict when a stock will bottom. If you buy that $20 stock and set a 40-per-cent stop-loss, you could “stop out” of the holding when it falls to $12 – only to watch it rebound ferociously weeks or months later.”

Reese also notes that stocks often experience significant volatility that doesn’t have any impact on their long-term prospects. “For instance, small cap stocks … have an annual standard deviation of 23.2 per cent from 1972-2013 (and that figure jumps significantly if you go back to the mid-1920s) according to 2014 Ibbotson SBBI Classic Yearbook,” he says. “So this means that if small cap stocks have returned 11 per cent to 12 per cent annually over the long term, the performance around that average return can vary by 20 per cent to 30 per cent the majority of the time. Running too-tight stops could wreak havoc on an investor’s portfolio as the normal volatility could easily result in getting stopped out and a ‘whipsawing’ effect.'”

Stop-losses can be a good tool, Reese says — if you use them properly. He offers three rules for getting the most out of stop-losses. Among them: Use a “dynamic” stop-loss target. A dynamic stop-loss is one that is adjusted based on how the market performs from the time you’ve purchased the shares you own, rather than being a fixed percentage regardless of market conditions.