Stop-loss has a bad reputation amongst retail traders. The thought of hitting a stop-loss is enough to scare even some of the experienced traders. But is stop-loss really needed for trading? What if the stock reverses and hits my target if I don’t use a stop-loss? Can’t I just trade without using it? The answer is – NO! Stop-loss is a trader’s shield whose job is to protect the trader from a heavy loss. Most of you might be thinking, using a stop-loss still results in a loss. So how is using a stop-loss a benefit for me? First let’s look at what is a stop-loss.
Stop-loss is a predetermined price at which a trade is considered to be a failed trade and the trader decides to square off the position. It is the amount of loss which a trader is willing to take in order to avoid further losses. Stop-loss is calculated using stock charts with the help of technical analysis.
Stop-loss is a trader’s best friend which protects traders from suffering devastating losses in bad trades. Your goal in trading is to make a lot of money from good trades and get out quickly from bad trades. If this technique is followed then a trader will make money when all trades are combined.
Let’s take a look at our two traders – Ram and Shyam. Ram always follows stop-loss religiously whereas Shyam does not believe in stop loss. Let us suppose that they take the exact same trade – Ram trading with a strict stop-loss and target whereas Shyam trading with only the target and no stop loss. Here is how the results might look after 10 trades each.
As it can be seen from the above table, even though Shyam hit his target more often (stocks number 2 & 4 reversed after hitting the stop-loss for Ram and went on to hit the target for Shyam) he still ended up with a much lower profit. Because he didn’t use stop-loss! Not using a stop-loss caused two major problems. First, a large portion of his capital got wiped off in bad trades because he didn’t limit his loss. Limiting your losses by using a stop-loss will protect your capital. Second, as the bad trades kept on going in the opposite direction he didn’t only lose money but also lost precious time. Ram has the ability to used his capital after squaring off bad trades towards new trades to make money whereas Shyam kept his capital blocked in a bad trade losing out the opportunity to enter a new trade.
Trading is all about money management. Not every trade is going to hit the target regardless of your level of expertise. Your goal as a trader is simple – minimise losses and maximise profits so that you will make money in an overall sense. A trader needs to be prepared to exit a bad trade with minimal losses (that’s why traders use stop-loss) and stay in the winning trades for longer to hit their targets. This will make sure that just like Ram, you too will hit your targets while losing not even a single rupee more than required. This is the recipe of making consistent profits in stock trading with your best friend – stop-loss!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
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This is very tiny matter but keeps important role in trading. Thanks.