The secret of how to earn money in the stock market is not to be right every time but to lose as little as possible when you are wrong. How do you understand when exactly you are wrong? The basic idea is simple enough: when the stock price drops below the price you paid for it is when you did something wrong. The main purpose of trading is to stay in the game. A dangerous delusion is to assume that, once the shares fall, they are bound to return to the same position. Many do not. Investors (and often these are former traders), permanently stuck in unprofitable positions because of the no loss limitation are no longer able to earn money in the stock market, as their capital is at best frozen and at worst - is already catastrophically small.
What is Stop loss in share market and how does it help in the situation described above? Stop loss is a protecting order, which is placed in the trading terminal in order to limit losses by automatically selling the shares in case their price has fallen (for bear market - has risen) from the level of risk acceptable to a trader. When you put a Stop loss, you control the risk because you determine the amount that you can afford to lose on your own. Market participants who speculate using borrowed funds and ignore Stop orders at the same time are certainly doomed to lose their trading capital.
Where exactly to place a Stop loss is an eternal question and a daily headache for almost every trader. There are no clear-cut recommendations in regards to it. The market often does not help knocking out the stop and immediately turning around to move further in the right direction but without us participating in the trade. This an unfortunate position for a trader and they have nothing to do but count unnecessary money losses. At such moments it is important to calm down and remember that small losses are a sort of payment for insuring insurance the capital, which we will need for profitable trading the next day. And each trader has to make decisions about a Stop loss by themselves. At least because they know the size of their trading capital, their trading system and most importantly, their personal tolerance for risk.
Small losses are inexpensive and the only insurance you can provide for your investments. Even if shares move up after you sell them and many, of course, do exactly that, you will keep all your losses low. Moreover, you will still have money to try again and find the right shares. When choosing the conditions for setting a Stop loss, it is important to avoid extremes. The stop that is too close threatens premature activation (especially with false breakdowns) and multiple small but gradually increasing losses. A very distant Stop order increases the likelihood of an unreasonably large loss if the market behaves unexpectedly. At the same time, speculative trading strategies require minimal risk from active traders. Meanwhile long-term investors can afford to put the stop further so that it is not affected by the inevitable market noise.
The "buy and keep" strategy, which was criticized after the crisis, actually works and enriches those who use it competently. In other words, wise investors do not buy shares at the top of the market only to be horrified and sell everything after its fall; instead, they confidently buy securities, for example, with a very effective signal showing a price breakthrough and keep them patiently. If they are being disciplined, they set the stops that they regularly adjust as the price rises. And it is Stop losses that will not allow the market to prevent all the profits in case of a collapse, which, as history shows, no one can predict.
The main recommendations for limiting the risk mostly refer to the principles of money management and the psychology of trading. Also we suggest sticking to some rules for working with a Stop order:
Beginners are often confused, where exactly to put Stop loss and Take Profit in each specific case. By setting TP, we decide where our target level will be and if the price reaches this level, we want to exit the market and take our profit. The size of Stop loss and take profit are connected and not in a programmatic manner but from the point of view of money management. The size of a SL should be at least two times (or better, 3-5 times) smaller than the size of a. So at the expense of one profitable transaction it is possible to cover the loss from several unsuccessful transactions. In this case, a Stop loss should not be made too tight as this will lead to frequent false alarms.
Experienced traders do not use extremely close stops. According to Larry Williams ("Long-Term Secrets of Short-Term Trading") we must give the market space for some movement but it should not be too big. By the way, stops also help the investor keep their portfolio spotless relieving them of securities that did not justify the hopes for profit. This is done in order to shift the funds into strong, growing stocks. In any case, whatever strategy you choose, rest assured that a Stop loss increases the efficiency of trading and also protects a trader's emotional stability from the exhausting stress of the constant need to control open positions.
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