To Win in the Stock Market use Stop Loss

Stop Loss to make money and win

The Stock Markets are unique and full of uncertainty. In real-time the markets are complex, but after the fact everything looks simple. It’s this dichotomy that tricks many into thinking that there is easy money in the stock market. That’s where Stop Loss comes in.

As an investor or a trader you can hope for a stock to go up or down, but you can’t control it. Stock market is a collective reflection of thousands and millions of participants and no single entity has any control over it. You are dealing with geopolitical, environmental, financial, technical, human and many other uncontrollable factors every single day.

You control the following:

  1. Which stock to buy?
  2. When to buy and quantity?
  3. What price?
  4. When to sell?

Almost everyone is good at the first three steps. It’s the “when to sell” that’s hardest in the stock market. If the stock has moved in your desired direction then selling is somewhat easy.

So, lets focus on when the stock has moved in the opposite direction and there is a loss. Many of us are reluctant to sell and close the position when there is a loss. Even if it’s is a small loss, it’s against the human nature to accept defeat. Often times a small loss turns into a major setback – both emotionally and financially.

The problem is the missing Stop Loss strategy in investing. Solution is right in front of us but we don’t use it.

Winners use Stop Loss.

The deeper the losses the longer it takes recover to get back to break-even. Let’s say you have a $100 stock and you sell it at 5% loss ($5). Now you are left with $95 capital. If you recover just 5% on your next trade you are at an overall loss i.e. $95*5% = $99.75. Therefore, you will need to recover 5.26% to break-even i.e. $95*5.26% = $100.

Loss Recover to break-even
5% 5.26%
10% 11.11%
15% 17.64%
20% 25%
40% 66.67%
50% 100%
70% 233.33%
80% 400%

The table above highlights the effort required to break-even. To stop the situation getting out of control, it’s important that you enter stop order as soon as the position is filled. Think of this stop order as an insurance to protect you in case the trade goes against you. If your stop loss order is triggered, 1) you are protected from deeper losses and 2) you now have the capital available for other trades.

Types of Stop Loss orders

Conclusion

  • Cut your losses sooner rather than later. The deeper the losses, the longer and harder it gets to recover.
  • Select stop price within the range provided in the stock pick alert.
  • Always enter stop loss order immediately after the position is filled.
  • Honor the stop loss. Only then you’ll find the next trading opportunity.
  • Watch your trade and narrow the stop loss as the trade starts moving in your direction.
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8 Comments

  1. Emily January 1, 2018 at 7:41 pm - Reply

    Happy New Year!

    Stop Loss. Two words but THE most important words in trading. Your breakdown in the table to show that profits are required in the next trade to break-even overall is simple yet powerful. I’ve derailed from my plan and moved and cancelled stops on several orders to learn the lesson VERY hard way. Nicely laid out in the article above.

    BTW, sometimes your stop range in the alerts is little tight. I usually give some room for the trade to work and let it hit the stop if it wants to.

  2. Jim December 16, 2016 at 11:54 am - Reply

    Stop Loss is good in theory but hard to use on live trades. I have no problem using it on paper money account but when it comes to actual trading account, I frequently move stops or don’t use it at all.

    Anybody else in same boat?

  3. Martin November 28, 2015 at 10:48 pm - Reply

    There is a reason some major exchanges are getting rid of stops. Large HFT firms (and others) can read your stops from a mile away and act on them accordingly when they are given information in exchange for order flow.. PayForOrderFlow..

    • eStockPicks November 29, 2015 at 11:33 am - Reply

      Hi Martin,

      Thanks for the insights. HFT algorithms and others running through the Stops and shooting right back up/down is something we’ve seen many a times. But it’s imperative to ensure that a stock position does not cause a big drawdown or whip out an account. A trader should always use some mechanism to limit losses. Some use Mental Stops for the very reason you mentioned above.

  4. Harry November 23, 2015 at 10:31 pm - Reply

    I read somewhere that NYSE and NASDAQ is eliminating stops orders soon.

    • eStockPicks November 24, 2015 at 4:15 pm - Reply

      Hi,

      Thank you for the comment. You must be referring to this article.

      However, stop orders play critical role in current trading systems at several large institutions and at retail level. Brokerage firms will continue to offer it one way or another… they already do it through their systems. Has anyone heard from their broker about this upcoming change from the exchanges?

  5. John November 19, 2015 at 10:43 pm - Reply

    Some brokers like TDAmeritrade provide trigger order types that automatically submits stop and profit target orders once the position is filled. If the profit target is reached, the stop order is cancelled and vice versa.

    • eStockPicks November 20, 2015 at 9:40 am - Reply

      Hi,

      Thank you for the information. Brokerage firms offer different order types as added service to their customers like the one you mentioned above. There is also trailing stops which is very useful when you are not in front of the computer all the time. For a long trade it continuously trails the stop price higher as the stock keeps moving in your intended direction. Similarly it’s the opposite for short trade.

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