The Stop Loss - The Thin Barrier Between you and Financial Disaster
Every trade you embark upon carries with it the possiblility of your stake being wiped out. Many stocks fall (quickly sometimes) until they are worthless.
A sure sign of an amateur trader is that they sell their winners too soon while holding on to their losers. This trading behavior leads to a portfolio of substandard stocks. The amateur's funds would have performed better had they been invested in an index tracking fund.
No trading system is perfect - all pick their fair share of losing trades. The secret to trading successfully is to get out of the bad trades with a limited loss and to stick like glue to the good trades for as long as they last.
To avoid sticking with losing stocks, we set strict stop losses.
Some people like to set each stop loss at a fixed percentage. Any time one of their stocks falls by 10 percent, say, they sell the stock. We can term this a trailing stop loss. It trails the share price each day. If the stock rises, the stop loss rises at the same time and always lies at 10 percent lower than the price you paid or the highest price reached - whichever of these is higher.
Rather than using a set percentage, many traders enjoy more success with their stops by taking account of the history of the stock they are trading.
If, for example, a stock has found support at one or more prices, it is often productive to set the stop loss a few ticks below a natural price support level.