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Stop Loss Discussion

Thanks to Jonathan Burton of MarketWatch for including some quotes from me in today’s WSJ article on stop losses [1]. Jonathan brings forth some interesting discussion regarding the use of stop loss orders, so be sure to check out his article.

Stop Loss Orders - WSJ [1] Click to visit WSJ article

I’ve discussed the subject of using the stop loss order [2] here before, and it’s one habit that I think is imperative for traders [3] who care anything about consistent results and capital preservation.

Some additional comments on stops:

* A stop loss is your emergency exit, your safety net, your plan B when things don’t work out quite like you had planned.

* Even if you’ve never been taught how to set stops or an approach to determining which levels could serve as locations for your stops, choosing an arbitrary price to set your stop is better than not having one at all. Deciding on stop loss levels will largely depend on a couple of factors: the individual stock in question’s personality, and the overall market’s behavior at that time. Taking those into consideration should help you gauge an appropriate spot for an exit, which also is related to position sizing [4].

* Capital preservation [5] is a priority to traders, but even longer-term investors would be better off incorporating some risk management elements into their plan. It all boils down to respecting the market and setting that ego aside. Your need to be “correct” can become costly if you allow it. So respect the market, or it will force you to respect it! We have to accept some level of risk in order to profit in the market, but even a small measure of humility should be a part of the plan because your timing may be off.

* Consider setting multiple stops for a longer-term position so that you won’t get shaken out on a small dip but at worst you’ll be reducing your position size as the stock moves against you. Your final stop would be in an area that on the chart it’s clear the entire trade has reversed course. Partial sales offer a lot of freedom, so remember that you don’t have to be “all in” or “all out” of a position. Scale out appropriately to reduce risk when you see fit.

* You don’t have to win on every trade, so look at stop loss orders as a way to protect your long term odds of success. Give yourself the best chance of profiting over time by preventing big hits to your account. You want to avoid ever going from stockholder to STUCKholder! Getting deep in the hole on any trade or investment costs you opportunity elsewhere, along with costing you your objectivity. All of us are wrong from time to time in the market, but the best traders know how to limit the damage done when they are wrong. The stop loss allows you to emulate that trait.

* Today’s commission rates are low enough that it’s sensible to use stops and then re-enter the stock later if you see fit. Stated otherwise, it’s easy to reverse that sale and quite inexpensive to do so.

* Every broker offers at least a basic stop loss order, with many brokers (including mine [6]) now offering advanced order types which let you specify multiple conditions that must be met before your stop order gets triggered. That’s a huge tool for today’s traders and investors, so use conditional orders if they’re available to you.

The bottom line is this: small losses are the key to long-term success, whether you’re an investor or a trader. The stop loss order exists for the very purpose of limiting your “wrongs,” so use them!

Jeff White
President, The Stock Bandit, Inc.
Swing Trading & Day Trading Service
www.TheStockBandit.com [7]

[tags]Stock Market, Day Trading, Stock Trading, Swing Trading, Stop Loss, Investing[/tags]