Make use of Stop Loss Orders

  1. With trading we all will have disappointments and losses. That is just a fact you have to be able to accept and manage according to your rules and stick to it as we say. Anyone can manage a winner it takes a trader to take a loss. So when you are not in the zone due to losses or other external reasons keep your trading account closed as the market will just mess with your head even if you win if you trade for incorrect reasons.
  2. Over confidence in trading can be deadly. All this nonsense that some tutors try to sell you about adopting a winning mindset or ‘can’t lose’ trading systems play into your greedy rat brain, and serve to suck money off you with their promises of mega moolah. Good traders however approach the markets as losers – not winners; they fear the consequences of several trades going against them.
  3. Remember losses count. In fact they count more than gains because of the disproportionate return required to get your money back. In other words, it is more difficult to recover a loss than to make a gain. There is a tough rule of financial mathematics that states that a 10% loss cannot be made up by a 10% gain. A 10% loss on a £5000 portfolio would amount to £500 – you would have £4500 left, if you manage to recover the 10% you would end up with £4950 (£50 short from your original investment even though you recovered in percentage terms). Losses not only lead to a ‘Loss Of Capital’ but also to ‘Lost Opportunities’. The latter refers to holding onto investments that are reducing in value instead of investing in one that could be making you money.

  1. So don’t run losses. Here it is useful to go over Pareto’s rule. Pareto hypothesized (if that’s the right word) that events manifest themselves in 80% : 20% proportions. He first noticed that 80% of the population will have 20% of its income. I checked out Pareto on a google search and found that a study in the USA found 80% of land was owned by 20% of the population and Microsoft reckoned that by fixing the top 20% of bugs cleared up 80% of reported errors. The classic 80/20 Pareto’s rule applies to trading and losses as well (and this is backed by industry statistics), 80% of traders and investors lose money when margin trading (be it forex, day trading, options, futures, spread betting, covered warrants..etc). However, on average, spreadbettors have more winning trades than losing ones… How can this be possible? The answer lies within the fact that losses incurred on losing trades are substantially bigger than the gain made on the winning trades – and this is because many traders tend to run losses. As human beings we are wired to hate incurring losses, yet we are still happy to run losses indefinitely in the hope that the market will turn in our favour eventually. And even then if a trader is sufficiently lucky for this to happen, most of the times they will close for a meagre profit. A bit of education stuff from CMC Markets also referred to him. They claimed that 80% of profits come from 20% of trades. It is also been proved that 80% of spreadbetters lose money to 20% that win. A larger independent study over thousands of traders and thousands of trades showed that 80% of would-be traders lost money. Let’s face it 80%+ do not make money trading but those 80% don’t make money in anything else either…but the 20% that do make money, make a lot.
  2. Do not trade on hope. ‘Riding it out’ and transforming a shorter-term trade into a longer term hold is not the answer, it is NOT trading. Head these words….USE STOPS. Don’t hope that losses will reverse; either learn to cut your losses quickly or you will inevitably at some point lose your shirt. So use stop loss orders unless you want to gamble your money! Risk control and mitigation are key to surviving in this business.
  3. Likewise, don’t fall in love with a share. Blind love doesn’t pay in trading as in marriage and a blinkered outlook can cause you immense pain, along with the angst and emotion that comes with it… You should always take an objective view no matter how much you like the enterpise or its products and should the company issue a trading statement where management state that they are experiencing tough trading conditions, then you have no reason not to believe them; never be afraid to take a loss. A bad trading update might be the precursor of worse things to come.
  4. Make sure you know what a stop loss order is and understand what stop loss sizes are and the significance that they can have in not only limiting your risk but also determining the bet size that you should take. Industry research shows that a number of spread betting accounts are opened with just £1,000 (which in my opinion is very low). A way to limit your risk is to limit your loss to no more than, say, 5% of your trading pot. Thus, someone who has £1,000 in his account shouldn’t risk more than £50 (5/100 X 1,000). If the instrument’s chart suggests a stop level 50 points away, then the right stake would be £1 a point.
  5. Be flexible with stops. In some cases it is better to set stop levels and distances based on a stock-by-stock basis rather than on a fixed basis since some shares tend to be more volatile than others (for example Financials/Miners vs Utilities/Retail) and need more room for the day-to-day market fluctuations.
  6. Do not move your stop loss once set. The whole point of using stop loss orders is to keep losses at a manageable level so as
    to preserve your capital to take advantage of winning trades. A way to do this is to stick to a fixed ratio to compute the profit per trade versus the loss; for instance if you use a 3:1 ratio, if your stop is set 30 points away, the limit price would be set at 90 (this way one winning trade would then pay for three losing ones). Another strategy is to use charts to identify exist levels. You might choose to exit a spread bet at a set percentage away from the entry price, at a previous historic resistance line or at a technical area as suggested Fibonacci or Gann levels.
  7. Do not set stop losses too tightly if the potential reward looks considerable. Remember that your trade is most at risk at the start as your stop loss is likely to be quite close at this point. Once the trade has moved well into positive territory you can move the stop loss level such that you basically breakeven and from then on you are just riding the trade… As the trade continues moving in your direction you can even add to it (since you are already in profit anyway).
  8. If the position is going against you, never move your stop further away. If you get stopped out, so be it. There’s always another trade. In my experience, moving your stop in very short-term positions is an undisciplined trading style and compounds your losses. You have set that stop for a reason so don’t get carried away. Remember, no stop loss will work if you keep moving it further and further away from your original position.
  9. Winning is good and losing is not. The longer you play the less it feels good or not if you are position sizing correctly. A trader narrated to me how he’s been trading for 4 years in and all he think about is his emotional attachment to trades or positions. If he thinks he needs to win then he gets out. Which is just discipline I guess. He used to do the research and read lots, now he doesn’t bother. He looks for patterns or movement or volatility. If he sees patterns he recognises or movement/volatility he likes then he trades. His win rate is high BUT his Risk : Reward is in the market’s favour as its typically 2 – 2.5 : 1 so his win rate needs to be high or he would go broke quickly. Prior to that he used to revenge trade or increase leverage after a loss. It can work a few times but then you end up in an emotional black hole and your money disappears rapidly. So now he doesn’t look for good days but just avoids the bad days. He says to himself that he doesn’t have bad days any longer. Bad days are for newbies. He is no newbie.
  10. Psychology is also a crucial factor to success in this game (though money is to be taken seriously) and it has helped me to view my profits and losses whether in running or closed as ‘points’ instead of £, so as to remove the emotion. Also, when one has a loss, it can help to view it as a friendly donation to the markets, as some you win and some you lose, with the hope that you are hopefully profitable in this game overall. Psychology is crucial and there’s a fine line to remaining in control of your temperament… Many times you would be amazed at the stops used by professionals, this is where psychology enters into trading and most people can’t stand to see a position underwater so panic and set a stop closer or manually close the position. This is where your plan should come into action, for example if you’re using a moving average cross to trade then you should wait for it to cross, backtest any moving average x trade and even for very successful trades you will usually see that the moving averages came very close to crossing before carrying on parting again. You can learn all you want about trading but if you do not have the right psychology for it then imo you will probably fail!
  11. Keep in mind that the biggest enemy is yourself. You soon learn what kind of screwed up individual you are. Better not have had a screwed up childhood cos you’re gonna lose a heap of money very, very quickly. Most can’t do it because of a lack of discipline or weak emotional/mental mindset…the need to be in the trade/feeling like you’re missing out…greed associated with wanting more from a trade (seeing good profits turn into loss)…fear resulting in cutting profits early (only to see the market rocket after you’ve closed out)…fear resulting in stops being too small (not letting market breathe)…laziness when they can’t be bothered with practising or reading (over-eagerness so you take your savings to the market and give it to the pros very quickly)…the need to be right because your parents always said you’ll never amount to anything (huge stops, take little profit here and there, get wiped out by a couple of bad trades; or you keep moving your stop back so it never gets hit until you cannot take the pain any longer)…your ego will destroy your account…the list goes on. The market will reveal what sort of screwed up individual you are. And only you are to blame. Don’t blame your teachers, your bully, your parents, your older siblings. The answer isn’t at the bottom of the bottle; that cigarette won’t help; comfort eating will make you look fatter. It’s survival of the fittest. There is no income benefit, no social housing, no NHS, no government bail out. You screw up, you pay the price.

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