How Setting Stops Saves Your Money

Provided By Ultimate Trading Systems

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 setting stops 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 setting stops 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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