Stop Loss Scenario - Cutting Your Losses Short

Understanding the importance of using some type of Stop Loss technique is a major step to helping make sure you'll be around for the next profitable trade that may arise.

As you gain experience trading and come to realize that you will have winning and losing trades, and more importantly accept the fact that you will have winning and losing trades, you will see the importance of cutting your losses short.

As a basic example, let's say you have 10 total trades that you have used $10,000 for each trade, and out of the 10 trades you have 6 winning trades and 4 losing trades. The 6 winning trades gain an average of 3% each totaling 18% in gains.

You held on to the 4 losing trades longer than you would have liked because you thought for sure that there would be a reversal as soon as you sold. You finally gave up and sold with an average loss of 7% each losing trade. While 7% may not seem like very much, these 4 losing trades now totaled a loss of 28%. Add this to the 18% gain of your 6 winning trades and you are now at a combined loss of 10% even though you had more winning trades than losing trades.

At this rate, you may be out of money in a few months wondering what happened and what you could have done differently to help minimize, or cut your losses short.

Enter the "Stop Loss". By using some type of stop loss order technique, you may have avoided the 7% average loss per losing trade, helping to minimize losses and allow you to keep more of your profits.

For example, if you purchased a stock at $10.00 and sold at a loss of 7% you would have sold at $9.30. If you used a level of 3% you would have then sold at $9.70 instead. Using the above example, 4 losing trades at an average loss of 3% each would have been a combined moss of 12%. Combine this with your 18% gain for the 6 winning trades and you would be ahead 6% out of 10 trades.

Know that this is a general example. There are various techniques and methods that can be used to help minimize losses but sometimes using a basic strategy works fine as well. Using various amounts of money per trade and varying gains and losses per trade will alter your personal results.

A key lesson to understand is that without some type of stop loss in place, whether mentally or physically, you will surely be more of a Gambler than a trader or investor who is on the path to being successful.

Where to place a stop loss is another lesson to learn and will vary depending on each persons trading strategy. I typically will use short term support and resistance levels. If I get stopped out of a trade with a loss, I move on to the next trade. Also, just because I get stopped out of a trade with a loss, does not mean I will give up on that particular trade for a possible future trade. Many times a pullback is more than we expect, only to reverse soon after we get stopped out.

Here is an example of a possible stop loss level using DZZ for a recent "shorting gold" trade. Notice this is a 10 day chart and the previous support level near $22.80 is highlighted red.

Stop Loss DZZ

In a case like this, some people would use $22.80 as their stop loss level. Others may allow for some false bursts through this level by using a level below this, such as 1% below this, at around $22.60 as an example. This would lower the probability of getting stopped out if indeed a price reversal was coming.

Related "Stop Loss" Pages on This Site:

Return From "Stop Loss Scenario" To "Stop Loss Order"

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