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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 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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