STOPLOSS -BIG Mystery -and its three golden keys
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About stoploss
Mystery of Stoploss
One of the great mysteries of trading is the dreadful stop.
what kind of stops should I use?
The philosophy outlined here regarding stops is very different than most others. when you learn how to use stoploss wisely, you discover that stops dont have to hurt.
Stoploss orders are the medicine of trading.
When your trade is sick, stops are there to heal it.
The big question is whether you like to take the medicine before you get sick
as a preventive measure or you wait till you really get sick,and then use the medicine. Natural choice seems to the part two.
There a few ways of using stops:
1. No Stop specialist
What do you call a trader that doesnt use stops?
An investor.
When a trader lets a trade go against him, he gets married to the stock, starts looking at fundamentals then becomes an investor.
I have seen people, especially six years ago, buy a stock at 100 and still hold it today, even though its a penny stock today.
2. Random stop or Gambling stop
These happen when a trader knows how much money he wants to risk on a stock, his bet on the stock, and that is his stop.
Buy ABC stock with a 500 stop, because that is all they can allocate for this trade. These PEOPLE think trading as gambling, they put their money on the table and forget about it.
The problem with this method is that it is not a method, there is no reasoning behind the placement of the stop.
3. Adding in stop
Some traders keep adding in money into their position as it goes against them. This is also called Dollar Cost Averaging.
When people begin trading they think that adding money to a position lowers your cost on it and, therefore, allows you to buy more shares at a lower price. Any Investor, who liked ABC at 60, surely will like it so much more at 50, right?
The reasoning behind this method is very dangerous.
You buy 1000 shares at 60, buy another 1000 at 59, buy another 1000 at 58. Now, your average cost is 59, not 60 as you originally wanted. The stock only has to jump up a single for you to break even, not two.
BIG PROBLEM
Problem comes when the stock keeps FALLING and you are now stuck with 3000 shares on the wrong side of a breakout.
People using this method wipe out their accounts. Traders will become investors. If not on the first 20 trades, then on the 21st that would wipe them out.
It only takes one large loss to devastate an account and devastate the trader.
Stops are like medicine for your trading.
The longer you take before you swallow the bitter pill, the worse your condition is going to be.
Preventive medicine works so much better, it prevents small weaknesses from becoming serious diseases.
Trade this way if you agree it is better
Follow this method of stops =it is very simple,
kNOW YOUR ENTRY REASON,
WRITE IT DOWN,
Always exit a trade
when the reason for your entry no longer exists.
Take Notice We said Exit, not stop.
We do not take stops, we exit.
At times its a negative exit, but it is still an exit, not a stop.
A stop loss stops your loss, we are not interested in the trade becoming a loss.
Explainas follows
ENTRY
If you have done your analysis right, you should be able to pinpoint an entry.
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An entry is a trigger
that starts a trend,
starts a wave in a trend,
starts a bounce,
starts a fade or a break out.
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BE accurate with your entry, AND your exit should be very simple.
If you entered a trend, you exit when you know that the reason for your entry no longer exists, when the stock refuses to start your trend.
If you entered a breakout, you know the reason for your entry no longer exists when the stock returns back into your consolidation.
So how much is that?
Your stop, or negative exit, (if you did your home work and pinpointed your entry,) is Noise + Spread.
Noise is the normal fluctuation of the stock and spread is the difference between bid and ask.
Basically, if you add them together, it is the amount that the stock can pull back before you know that your entry is wrong.
For example, in day trading, most of our negative exits are less than 1 RUPEE Most of the stocks that we trade have less than A COUPLE OF RUPEES spread and noise. In Swing trading, most of our negative exits are less than 10 TO 20 RUPEES(TEN TIMES plus THAT OF DAYTRADING) for the same reason.
Some people day trade with a RUPEE stop or even two or three rupees. If you do your home work and can pinpoint your entry, how many 1 rupee negative exits can you take before you equal one point or two points?
Imagine having 10-20 attempts for the price of one.
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Three keys
There are three keys to success here:
1. Pinpoint your entry You need to know exactly where to enter.
2. Know exactly where the reason for your entry no longer exists Where on the chart does price have to go to invalidate your entry?
3. Re-entry If the stock comes back and your setup is still valid, make sure that you re-enter.
Most of us pay less than 100 in commissions, which is a lot less than a devastating stop loss of multiple points.
If you have to pay 500 plus rupees for a trade that didnt work, it is a business expense, not a stop loss. It protects you financially and psychologically. It allows you to re-enter the trade without any damages.
If you exit with an expense of 1000, it will do a lot less damage than several thousands or your whole account.
How would you feel if you spent a few hundred bucks on a trade vs. lost several thousands on a gamble?
Traders need to get educated how to pinpoint their entries and know exactly when the trade is working or not, in order to keep stops down to business expenses, instead of serious losses.
The secret to longevity and prosperity in trading is
knowing why you are entering,
pinpointing your entries and
preservation of your capital.
Preservation of capital is always more important than capital appreciation.
Hope this helps your trading in some way.
Dedicated to maximizing your profits,
rvlv
For every winner there must be a looser