A loss never bothers me once I take it. I forget it overnight. But not taking a small loss when I could – that is what does damage to the pocket book and to the soul. Jesse Livermore
Taking your stops on a trade gone bad
The number one reason why many traders fail is they do not have a trading plan. They do not use money management or trade management rules. As a result their profitability is simply random. They place themselves at a huge disadvantage when professional traders are only happy to separate the unknowledgeable from their invested sums.
A new trader will often only have the vague idea that they are buying a stock in hopes it goes up. It was Will Rodgers who quipped, “If you want to make money in the stock market just buy a stock, and when it goes up sell it.” While someone who buys stock may not have any idea when they might sell it either (a target), it is the potential loss or risk part of it that this article is about.
This would be great if stocks only went up. But they don’t. They go down too. Good traders will win anywhere from 45% to 80% of their trades. This is a generalization of course, as the other part to consider is their average wins vrs average losses. But lets focus in on the fact the 20% to 55% of trades good traders take are losses.
One thing all these good traders will have in common is that they will take their stops when trades do not work out. This means that they have a price set before they take the trade that they will exit at if the trade gets into a loss position. This is not a line in the sand; this is a hard line in granite. If that stock price reaches the stop price it is dumped. This is how losses are controlled. This is how they keep those 20% to 55% of trades that are losses from doing more damage to their profitability.
Good traders take calculated losses (and calculated wins). In fact, you can tell a professional trader more from their losses than their wins. There will be no thought process or discussion in the traders mind on what they might do if the stock goes down and hits the stop price. No conditions or options to think about. They just dump it. If the stock has already shown it is not acting the way it needs to then there is no point in allowing it to continue on. Typically at the stop price the stock has negated the very reason it was bought in the first place.
In the deep nooks and crannies of human psychology it must be initially planted that every stock trade must be a winner, but the discipline to take stops when they are hit is simply necessary to last in this game and win long term.
The thing here to get is everyone losses money on some trades. This is true in every style of trading. Whether a trader is scalping the 2 minute charts for trades that last a few minutes, trades that last a few months, or trades that last years. Back in September 2008 when the market fell of a cliff virtually anyone that owned a stock took a loss. Professional traders lost along with everyone else. The difference here is they lost a calculated amount they had already agreed to lose when their trades hit their stops. Others of course lost much more.
Using September 2008 might be considered an extreme example, even if it did happen more than once (1974 1987, 2000, 2008). But even if it happened only once those that were caught like a “deer in headlights” because they had no trading plan and no stop fell backwards 10 years or 50% using the S&P 500 index as an average.
On a any other normal day traders without a plan to employ stops can still lose enough in one trade periodically to wipe out the profits on several previous trades. It is seen often that everything won in the morning is given back in the afternoon.
Kerry W. Given, a.k.a. Dr. Duke, in SFO magazine answers a readers question that is wanting to get back into the markets now that it is coming back after getting burned in the September 2008 crash. “…always have a stop loss order for every position. Portfolios with stop losses were automatically liquidated as the market collapsed in 2008, …leaving owners with minimal losses.” Given continued, ” This money management rule will prevent any one trade from becoming a devastating loss. This approach will also help you manage your emotions and minimize the stress of trading.”
Some where it was written as a guide for gamblers: “Do not do any thing that could bring about your demise.” Good traders don’t net the farm; they bet just a very small part of it and they stick to it.
For more information on stop losses and stop loss orders you can read the Investopedia page on this subject.
Trade with a plan.