Are you familiar with life insurance? Well, that’s kind of how Stop Loss orders work. With stop loss strategies in hand, when a trade takes the wrong turn, the investor can have his/her share sold for a loss. When you’re investing your hard earned money, it is important that you protect yourself and today, we are here to help you do just that. We would understand how stop loss works and some of the well know stop loss strategies for stock market trading.
How Stop Loss Works?
As the name suggests, Stop loss helps in “stopping” the loss. In order to prevent unforeseen loss, investors put a hard stop when their loss reaches a pre-defined threshold. It can be for a particular stock or entire portfolio. For example: if the stocks 10% of the original price, it’s time to sell it. For example, let’s say you purchase a stock that is at $50 a share – your stop loss should be set to $45. Of course, you could choose to sell if the stock drops to 20% – the percentage you choose is all up to you, but whatever you do, it is important that you stick with this. When you see that you’re losing money on a stock, sell it as soon as it loses the chosen percentage of its original value when you first purchased it.
When to Place the Stop-Loss Order
As soon as you enter the trade, place the stop-loss order. Some people choose to implement a mental stop, but personally, we don’t think this is a good idea. As soon as your stop-loss level is hit, you will want to pull out. If you over-think this, you’re only going to be setting yourself up for bigger losses.
Stop Loss trigger Price
The trigger price you choose should be set at price increments that are common. You see, prices like $100 are more common than one like $123.78. Are you wondering why we are telling you to go with price increments that are common? The answer is easy – when you place the trigger price at a common increment, the chance of the stock “trading through” will decrease.
Stop Loss Strategies
Percentage Fixed Stop
This is the most common type of stop loss where the trader fixes a trigger price where his position would be automatically squared off. This trigger price is in terms of a fixed percentage of buy price. For example: If a stock is bought at 100$, then 5% Stop loss will trigger an automatic sell order at 95$
Percentage Trailing Stop
This is an interesting stop loss strategy where Stop loss trigger price increments gradually if the trade is in your favor. You can specify the increment while placing trailing stop loss order. For ex: Suppose you bought a stock at 100$ with the initial Stop loss of 95$ and a trail of 0.5 points per 1 point. In this case, when the Stock moves to 101$ (in your favor), the stop loss would be auto adjusted to 95.5$. Trailing stop loss helps to make sure that your profitable positions doesn’t suffer big loss due to any black swan events.
A time-based stop loss approach would exit the trades with long phases of inactivity and sideways movement. If you bought a stock and anticipated higher and rising prices, but nothing happened and your trade just goes nowhere, it is very likely that your trade idea is not working out. In such cases, traders would do better to exit their trade and wait for the next trade signal, rather than wait and hope that price starts doing something.
It is a stop loss strategy which adapts to changing market conditions. When volatility is high, traders use a larger stop loss to account for greater market swings. When volatility is low, traders use a more conservative stop loss. Bollinger Bands and Average True Range (ATR) and some of the methods to define stop loss based on volatility.
Also Read: Ed Seykota: A Legendary System Trader
You see, the benefit of having a stop loss strategy in place will give you the time to focus on other issues at hand, instead of having to sit there and continuously monitor the stocks performance. If you are worried about a big loss, the proper strategies will take the heat away from that.
In the end, just make sure you keep an open mind and trade wisely. Go ahead and start using the above stop loss strategies for stock market trading to increase your chances of success.
It is important that you never regret a decision and don’t dwell on the past. Simply move forward with the next trade.