Stop loss: The money saver

The secret to making money constantly is in mastering the art of the 'stop loss'. Easier said than done, it also happens to be the most difficult part to learn. But believe me, whosoever I know as the great traders have this one thing in common - they are very clinical about cutting their positions the moment they get a doubt. I know some people who don't even wait for their stops to be hit and cut their positions the moment they realise that their idea or view has gone wrong.

Most of us are so used to winning in our lives that we just abhor the idea of losing. Unfortunately trading is a different ball game altogether and it requires us to first 'unlearn' and then 'relearn' to be successful here.?

As mentioned in some earlier posts, trading is just a game of probabilities and one can never be sure of the view going right. We take positions when we are 70-80 percent sure and then wait for the market to unfold itself. Of course we take help from the chart patterns and hope that the 'history will repeat' itself and many a times we are right too. However, in this globally connected world it takes ony one surprise to alter the course of the market and the history doesn't get repeated. In case the surprise is big enough the market reacts violently and we suddenly find our positions deep out of money. It is at this juncture that the stop losses help us by getting us out of the positions with minimal losses. I would advise the traders to place the stop losses in the system or with the banks or brokers so that we don't miss the levels in case we can't connect out of any reasons like the calls not getting picked up or the slow or not working internet and above all the general and fatal cause called the 'rethink'.?

There are three broad types of stop losses: 1. Technical based, 2. Risk Capital based and 3. Time based?

The Technical stop is derived with the help of the charts support and resistance points and it is always advisable to keep some cushion for the market volatility. Different people have different chart favourites and it also differs for different class of assets and markets. With a bit of practical experiences the traders can find them easily.

The risk Capital based stop losses are very easy to find once you have decided the risk per trade you are willing or allowed to take. For example a risk of ?10000 per trade will let you calculate your stop level very easily from your entry level. It will just be a mathematical calculation. There is also a slight variation of this type of stop losses. There are people who vary this stop loss and calculate it as a certain percentage of their overall risk Capital, say 1% of the total risk Capital. Obviously the net amount will keep changing with any further profits or losses. This type of a stop loss has the merit of letting the traders take more risk when he is in a winning streak and lesser risks when he has lost capital a number of times. The demerit is that the stop loss levels thus arrived are not the technical levels and the chances of their getting hit even without the view going wrong is higher. The solution for this problem is easy and we can tweak the quantum of the traded asset class so that the trade can incorporate both the technical based and the risk capital based stop loss levels.

The time based stop losses are of many types. One is when you decide to close the position after a fixed amount of time, say before the day ends or before some important data points, etc. Another type of time based stop loss is when you decide beforehand that the position will be removed if the hourly/daily/weekly close happens below or above some technical levels depending upon whether the trader is long or short.

A trader has to decide which type of stop suits him more. S/he can decide to keep a judicious mix of them all and see what works for him the most. It is important to note that the stop has to be decided first and then the initiation should take place. My advice would be to also note down the trailing stop loss levels before taking any trade. This has to be implemented without any further thoughts later on. In case there is a doubt, the rule is to first cut the position and then think. This way most of the 'position based biasness' will be gone. If after a careful consideration the trader thinks that the original position could have been kept s/he can reinitiate them with a stop loss of course.

Happy trading!!!