The
curse of STOPLOSS orders
Have you been puzzled on what is a good stop loss level?
Ever been bitten by a stop loss that just triggered before the stock
soared to the levels you expected initially, leaving you high &
dry, and counting your losses?
Does the triggering of stop loss alter your point of view from bullish
to bearish or vice versa?
If your answers to the above are Yes, Yes and No, then you are not
alone. A majority of the traders in the stock markets will have
a similar story to tell you about the curse of the stop loss.
Now, before proclaiming stop loss orders as a curse to the trade,
let us examine stop loss orders a bit carefully and a bit minutely.
The most common stop loss order is an order that you place against
your existing trade which has not yet gone into profit. e.g. You
buy a stock at Rs. 100 expecting it to go to 110, but currently
it is quoting at Rs. 98. So you decide to place a stop loss order
with your broker against this trade at a trigger price of say Rs.
94. So while you expect that the price of the stock will eventually
rise to 110, you also expect that the price may fall somewhat before
rising, and you expect this fall to be less than Rs. 6, so that
your stop loss is never triggered, and when it starts its rise again,
you will be able to collect a decent profit when the stock reaches
your target price of Rs. 110.
If this looks as simple as that, continue reading.
You might not realise, but by placing such an order, you are accepting
that
1) At the price of Rs. 94, you are no more confident of your target
of Rs. 110
2) At the price of Rs. 94, you are more interested in limiting your
loss rather than wait for the profit.
3) At the price of Rs. 94, you would rather book a loss of Rs. 6
or 6% and get out of the trade.
That is the curse of the STOPLOSS.
If you keep too tight stop losses, then you book too many small
losses. If you keep large stop losses, then you tend to book large
losses every time a stop loss is triggered. Either way, you are
the loser whenever such a stop loss gets triggered.
There is also a myth that stop losses will enable you to limit your
losses. Let us see if they can really do that.
In the above example, say the day ended at the stock quoting at
Rs. 98. So while your target of Rs. 110 is not yet reached, the
stop loss of Rs. 94 is also not yet triggered, you still have a
chance of collecting your 10% profit the next day, while risking
only 6% of your investment in that trade. Keeping this positive
thought in mind, you decide to carry forward the trade to the next
day, always believing that the maximum loss you will book is 6%
and no more.
On the next day, to your utter disbelief, the stock opens at Rs.
92 and goes down to Rs. 88 and now is again trading at Rs. 92. You
decide enough is enough, and you exit the trade at Rs. 92, booking
a loss of 8%, and patting yourself to have quit a loss making trade
at a good price.
Now look at what has happened!!!
Your stop loss, which was supposed to limit your losses at 6%, never
triggered and you were compelled to book a loss much larger than
what you could afford. Remember, booking a loss also means that
much less amount for the next trade, and that in turn means, that
much less profit.
That is the sting of the stop loss.
So why do traders and analysts give so much importance to a stop
loss?
The answer is simple. They do not have enough confidence in their
targets, and they do not have the required patience for waiting
till their target is achieved. And to justify their stop losses,
they will ask you whether you will drive a car without brakes?
So, will you drive a car without brakes? Again the answer is simple.
No. One should never drive a car without brakes. But then, the question
of driving a car is highly misplaced when asked in the context of
trading in stocks.
In the stock markets, ask yourself, are you really a driver? or
are you a passenger? Also ask yourself, would you see the stock
market as a collection of cars going in all directions, or see the
stock market as a fleet of buses which either goes in one direction
or the opposite? Once you have grasped this concept, that in the
stock market, you are not the driver, but just a passenger, who
is on look out for a bus that will take him to his destination,
PROFIT, then you are ready to be free from the curse and the sting
of stop loss.
So before you enter into your next trade, ask yourself all the questions
that will ensure that you catch the right bus. Once you catch that
bus, remember, there will be traffic jams, road blocks, no entry
roads, etc. which might make the bus seem to go in the opposite
direction, but eventually it will take you to your destination of
PROFIT.
If you are not sure of the trade, and you start thinking what would
be the ideal stop loss? Think again. Think that this might be the
bus that is going in the opposite direction and don’t take
that bus at all. In simple terms, do not enter that trade, in which
you are not confident of profits. Usually, such trades are ideas
from hearsay, sms messages, recommendations by non-professional
analysts, etc. So whenever, you wish to put a stop loss, just avoid
that trade and you will avoid that curse and sting of stop loss.
Remember, in the stock markets, there is no loss unless you actually
book it.
It is always better to plan your entry and targets into a trade,
rather than getting stopped out due to the volatility of the markets.
We, at www.itrade4profit.in do all the necessary analysis of “The
trading sentiment” and “The counter activity index”,
before making any recommendation as a “Positional Call”.
And to these calls, we never give any stop loss levels. But as you
can see, even if these recommended stocks falter for a short period,
they eventually reach their targeted profit levels within a very
short span.
There, of course, are other types of stop loss orders than what
we have discussed in this article. These are “trailing stop
loss orders” and “Entry barrier stop loss orders”.
And what’s more, these are good stop loss orders and you should
form a habit of using those stop loss techniques. But we will discuss
them in a later article.
As for now, remember not to enter a trade without proper analysis
and without getting enough self confidence about the profitability
of that trade. And once you enter, keep your self belief intact
until you reach the target profit levels.
Happy Trading !!!
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