How Setting Stops Saves Your Money
By Ultimate Trading
You Must Learn How Setting Stops Can Save You Thousands
Setting stops is an imprecise science and involves a lot of trial
and error, but it is an integral part of being a successful trader.
A good analogy is to compare
to buying insurance for your business. Should you avoid insurance
altogether just because you're not sure exactly how much you need,
or because it will cost you a little money? No. Instead, you
estimate and do the best you can, and in the end it will be well
worth the effort.
Where insurance limits risk of loss through disasters, setting stops
limits your risk of loss on bad trades. Setting stops make it
possible to take small losses and get out when a stock goes against
you, protecting your capital. Yet, some traders find that they are
unwilling to take a loss on any stock. They don't want to admit that
they made a mistake.
What often separates a good trader from a bad one is the ability to
take small losses. Your goal, as a successful trader, is to take
small losses and make big gains by setting stops. If you do this,
you'll be profitable. But, you ask, what if you stop out of a stock
you still want to trade? Well, you can always buy it back later, and
likely at a better price, if the trade still has potential.
Besides limiting risk and helping you take small losses, setting
stops is valuable because they protect profits on winning trades. As
I discussed in a previous article, you must lock in your profit when
you trade, or you can lose it. You can ensure that you keep your
profits by using trailing stops. A trailing stop is just like
setting stops below the current price of a long position,
progressively moving it up as the price of the position increases so
that the stop follows the position up. For a short position, you are
setting stops above the current price and then move it progressively
down, following the position as it trends downward.
This means that once you have a profit, you are
nearer to the current price so you'll stop out with most of your
profits intact if the position moves against you. If the stop
executes and you decide you want to trade the position again, you
can buy it back at a better price than you sold it for and then ride
it up again. That's how a good trader makes and keeps money, by
taking small profits multiple times, rather than risking too much
waiting for a big win.
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