A
stop-loss is a
market order to close a trading position as soon as
the financial instrument reaches a specific (designated)
price
level.
A
stop loss is not hidden in a black box, but visible to other market
participants who may know exactly where the stops are in the
financial markets. Therefore, it is one's responsibility to choose
the most suitable stop-loss that can protect against larger
losses.
Though,
stops are not completely hidden, one can partially conceal them by
setting them gradually.
For
instance, if a trader intends to use thirty pips stop-loss, but does
not want to disclose his intent straight away he can initially set
the stop-loss at twenty pips. By doing so, other market participants
may think that he is using only twenty pips stop-loss. However, he is
free to move it to thirty pips in one go. Or, he can change it twice.
In that instance, he may change it into twenty-five pips before
moving it one last time to thirty pips.
Note
that it is often the desire of many market participants to take out
others' stop-losses, and use them as the fuel for their own trades.
They delight in taking others out of their trades. Generally, one
ought to protect trading positions especially if one is risking
substantial amount of money.
How To Set A Stop-loss
Setting
stop losses is a matter of preference or risk acceptance. It varies
from one trader to another.
However,
there are common rules.
1/
Always set the stop-loss few pips above or below a key support or
resistance level.
2/
Set the stop-loss few pips above or below first buyers and sellers'
stop loss.
3/
Set stop loss according to the characteristics of the financial
instruments.
4/
Set the stop loss in accordance with the risk reward ratio of the
trade.
5/
Set the stop-loss in accordance with the probability of the trade.
6/
Set the stop-loss in accordance with the type of trade one is
taking.
7/
Set the stop-loss on the signal time frame especially if one is swing
or position trading.
Sometimes,
day traders can set their stop-loss on the entry time frame though
that is not
the
best practice.
Moving
Stop-loss
The
General rule is never move your stop-loss. It makes sense because if
one is moving the stops, one is also increasing the risk exposure.
Usually those who move their stop-losses are traders who do not want
to cut losses or minimize the risk. In many cases, they end up wiping
their trading accounts
when a small loss grows
to become a colossal loss.
One
may experiment a bit, and try to determine the most appropriate
stop-loss for each financial instrument one is trading. If for
instance, one ascertains that one should fifteen pips for day trading
X-stock, one can stick to that. Also, one does not need to move that
stop in many cases.
For
scalpers, it is almost dangerous to move stop-loss if one is
scalping. In fact a scalper should never move the stops.
A
scalper who moves stops is not serious. That is it.
Day,
swing and position traders do
strategically move their stops when they do not want to reveal their
maximum stop-loss to the market straight away.
In
fact the only time, one should move stops is when one has a strategic
reason to do so; instead of the fear of taking a losing trade. In
truth, traders with more experience will succeed in moving their
stop-loss without being cooked (so to speak).
Emotion
And Stop-Loss
There
is so much emotion attached to the application of the stop-loss.
Remember, the last time when the price came many times quite close to
the stop-loss. Initially,
one thought it is
all
well, but it finally hit the stop before heading in the direction one
was expecting it. Ouch. The
price hits the stop-loss then moves up or down as one initially
thought.
That
feeling is unforgettable to all technical
traders
whether one is new or more advanced trader.
Many
times, traders also
do
use useless stop-loss because they can not afford a better one. In
this instance, the emotion is unbearable as one is crossing fingers
in a desperate hope that the price will just go straight away in the
direction one is expecting it without any fluctuations.
The
fear of losing, pain of past losses, and the pressure of the trade
can push one's adrenalin to the
highest
level.
The
best way to handle that emotion is to accept that every trade always
has few
elements of risk. Also, one must accept that losing trades will
always occur even if one has done everything right. A simple way to
control
the madness of stop-losses is to never use more than 5% of the
trading account. So one opens ten trades or hundred trades, those
trades should never exceed the five percent at any time.
That
strategy will keep one as
disciplined
as
a military personal, and
help one to avoid
blowing the
trading account in case all trades turn negative.
The
subject of stop-loss divides the financial markets into three
groups.
First
there are
those
who think that trading is
all
about being
really lucky,
having
best chances,
and mastering
gambling.
For that group, they do not see why one should bother about setting
an appropriate stop-loss or protect trading positions.
The
second group is for those who are smart risk takers. Though, they do
move their stop-losses,
they understand the risk, and take other measure to hedge their
positions.
The
third group is for those who hate to lose, but take maximum
precaution to handle the risk. They very disciplined and risk averse.
They will not move their stop-loss, and the risk control is their
first priority.
Furthermore,
they also put
defensive
measures in place to protect their positions.
Conclusion
If
one is an active day or swing trader or scalper, one ought to use a
reasonable, but suitable stop-loss to manage the risk. Generally,
position traders use call or put options to hold their positions. In
that
instance, their risk is the expiration
of
the options; and the premium that they have paid. Those options or
position traders usually use hedging strategies
to
defend
their positions.
They also put in place defensive measures to defend and protect
colossal positions. Other market participants use binary betting
instead of the normal spread betting to reduce their risks. Whether,
one is a normal technical day, swing, scalping trader or position
trader, one will take appropriate measures to manage the risk.
Indeed,
the number one goal of all those exercises is to stop losses. After
all, financial market participants who do something about stopping,
reducing or managing losses will survive the ups and downs
of this moody financial market.
Always
use a stop loss, and do not forget to use one. The ultimate
goal is
not to lose, therefore,
one can only do that if one can control the losses or risks. Never
trade any financial instrument if there no way one
can
control or stop the loss.
