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Investing Articles

Always Use Stop-Loss Orders When Trading

No one can ever know, with 100% certainty, when a market is going to turn against a position or how fast. While it is possible to have a high degree of certainty that a market is going to move in a given direction, as FDate turn dates have proven since 1996 (http://www.AmazingAccuracy.com), nothing is 100% guaranteed in trading.

Even trading highly accurate turn dates requires the use of stop-loss orders when trades are made. The great W. D. Gann, well known for making incredible market predictions and a large amount of money trading, admonishes his students to always use stop-loss orders.

The key to successfully making a business out of trading is to properly manage your money and your risk. Your money and risk go hand in hand.

For example, in managing your money you need to look at how much you have in your account and then plan on only risk a small percentage of it on any given trade. If the trade goes against you by this certain percentage, you must exit the trade.

For most traders, they find it hard to exit a losing trade in hopes that it will recover and turn out a winner instead. More often than not, sadly, the loss gets worse and the account takes a bigger hit. Many times, this ends up wiping out the account and putting the trader out-of-business.

In order to implement a proper money and risk managing scenario, the trader needs to be disciplined to accept the small loss and get out. The problem that often arises is that decision making starts to get a bit foggy for many traders as they watch the prices moving up and down, and the decision to exit is often being second guessed or questioned during the trade.

To help in regards to this problem that most traders have, the risk must be assessed and the price to exit must be planned BEFORE the trade is initiated. Once the trade is active, a stop-loss order should be placed at the predetermined price level and not moved except when the plan calls for moving it towards and into profit, not the other direction.

As an active trader since 1989, I have experienced both sides of the fence when it comes to stop-loss orders and taking losses. In my early years, I made the mistake often to leave off the stop-loss or to move it deeper into losing territory in hopes of my trade recovering. Big mistake! In time I learned the importance of assessing risk and sticking to my risk amount, placing a stop-loss at the price representing my maximum allowed risk exposure. This has paid off handsomely!

Often traders do not know where to place their stop-loss orders, not liking to use a price value dictated by allowable loss based on account size. I personally can attest that this is not my favorite approach either. In fact, the market does not care that you only want to risk 1, 2, 5 or 10% of your account on the trade. The market will trade where it wants to trade.

 


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What I have personally found to be valuable in determining stop-loss price locations is noting where previous swing bottoms and tops have formed. If I'm looking to buy, the wise thing to do is to buy in a bullish trend that is making higher swing bottoms. If the previous swing bottom is within acceptable range of my risk allowance based on my account size, then I have a logical place to put my stop-loss. It is expected that the stop-loss order should only be hit if the trade assessment is wrong to begin with. Consider the stop-loss your 'worse-case' scenario. Once placed, you do not need to watch the market so carefully and can go about your business, depending on whether that is what type of trading you prefer to do.

Stop-loss orders help to take your emotions out of the trade. If you can discipline yourself to keep the stop-loss in play and not remove or move it (except towards profit territory), you then do not have to concern yourself with foggy reasoning during those times the market is not moving in your favor.

Wise advice is to let your profits run and keep your losses small. Stop-loss orders are powerful tools for allowing you to do this. While they help you keep your losses small, they also can be used to trail your position as it goes into profit, allowing the trade to accumulate profits as long as the market does not change trend. At some point it will, and then your trailing stop-loss order is hit and you are out with your profits.

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