| Sometimes the best way of lowering exposure to | | | | per share or $500. This represents the most you are |
| risk is not to invest at all! However, when we make | | | | willing to lose, regardless of which way the |
| the decision to jump into the muddy waters of the | | | | investment goes. |
| stock market, its always a good idea to have a life | | | | If the share price moves to $7.00, instead of setting |
| jacket ready, just in case. | | | | your stop loss at $6.30, (thus risking $0.70 or $700 of |
| We all have stories of that "must have" "can't lose" | | | | your money), you would set your stop loss at $6.50, |
| stock that looking back, we didn't really need to buy, | | | | which risks the same $500 you were initially willing to |
| and it definitely lost. So, how to best protect | | | | lose when you first started. |
| yourself when the markets disagree with your due | | | | This little twist helps you keep more of your |
| diligence? Trailing stop loss. | | | | profitable investments. Why put more profits at risk? |
| It's important to understand the psychology of | | | | The second stop loss strategy is, although a little |
| investing. When we make money, there is instant | | | | more complicated, will protect more of your money. |
| euphoria. When we start to lose money, there is a | | | | While we would love to take credit for this strategy, |
| sudden "deer caught in the headlights" type of | | | | we found it when reading Chart Trading by Darryl |
| emotion, which makes us unable to do the right thing. | | | | Guppy. This strategy starts by looking at your overall |
| We fear that the moment we sell, will be the | | | | capital, not the amount of the specific investment. |
| moment that it starts to rebound. Not only do we | | | | For example, if you had $20 000 in your investment |
| fear that we will be that guy who sold at the low of | | | | account, you could trade 51 times if each time you |
| the day, but that we will miss out on untold fortunes | | | | invested you put 2% of your total capital at risk. |
| because we got out too early. | | | | While 2% doesn't sound like a lot, lets have a look at |
| While this happens, more often than not, a small loss | | | | an example. Given your investment account has $20 |
| turns into a much bigger loss. Remember, a 40% loss | | | | 000 in it and you only want to put 2% of it at risk, |
| started off as a 5% loss. | | | | you would be willing to risk $400 per trade. This |
| So what is the best stop loss strategy? Well, we | | | | ensures that you will have 51 chances to get it right |
| happen to have 2. One simple, one a little more | | | | before you run out of money. |
| complicated, but possibly more effective and capital | | | | Where you set your stop loss is basically the point |
| saving. | | | | where you are risking $400. Given our initial example, |
| The first strategy is called a "trailing stop loss". Its | | | | your stop loss would be at $4.60. If the price moves |
| simple and effective. We're going to add a small twist | | | | from $5 to below $4.60, you have lost $400. What if |
| to it. A traditional trailing stop loss simply means that | | | | you purchased 2000 shares at the same $5? Your |
| you set a percentage that you are willing to lose. For | | | | stop loss would be then set to $4.80. Anything below |
| example, if you purchase 1000 shares of ABC at $5 | | | | that, and you have risked more than $400. If you |
| share, you could set a stop loss at 10%. This means | | | | think that you want a deeper stop loss, then you |
| that if the stock dips below 10% of your purchase | | | | would purchase fewer shares. The idea is simple: you |
| price ($5 - 10% = $4.50), you're out of the market | | | | never risk more than the same amount per trade. |
| and no longer risking capital. If the share price moves | | | | As the price increases, you then change the amount |
| higher, you would set your stop loss at 10% below | | | | of your stop loss accordingly. If the stock hits $7, |
| the closing price. If ABC moves to $5.50, you would | | | | you would set your stop loss at $6.60. |
| set your stop loss at $4.95. If the stock drops below | | | | Given our initial stop loss strategy, assuming you lost |
| that price, you're out. | | | | $500 each trade, you could lose approximately 40 |
| By setting your stop loss at the time of your | | | | times before you ran out of money. However, what |
| purchase, you are taking the emotion out of | | | | if you purchased 2000 shares at $5 each? Your 10% |
| investing. Specifically, you are taking out the "deer | | | | stop loss would put $1000 at risk. This will lower the |
| caught in the headlights" emotion. This will save you | | | | number of chances you have at getting it right. |
| grief and will save you money. If your stock moves | | | | Its up to you how much money you are preparing to |
| like you think it will, you can lock in your gains | | | | risk. Many investors think of the ways they are going |
| automatically. | | | | to spend their profits before they are made. Its |
| Our twist to this strategy though, is to first establish | | | | much better to think about the amount you are |
| the dollar amount that initial stop loss is worth, and | | | | prepared to lose. This way, when your hard work |
| let that dictate what your stop loss will be. | | | | pays off, you'll appreciate it more. On the other hand, |
| Given the same example as above, your initial stop | | | | if the market disagrees with you, you can still keep |
| loss would be $4.50. You would only be risking $0.50 | | | | the majority of your money! |