Myths About Stop Losses
Day traders use a variety of orders to enter and exit their trades, and one of these orders is a stop loss order. A stop loss is an exit order that is used to limit the amount of loss that a trader will take on a trade, if the trade goes against them. Which happens frequently.
When we enter a trade we set our stop loss one cent beneath the low of the entry bar. (If short selling, one above the high of the entry bar). Contrary to popular teaching we do NOT set our original stop losses with the intention of ever having that stop loss hit. As day traders we are constantly trading with the momentum. Some people call it scalping. When we enter a trade we do so fully expecting that the price will increase shortly after we entered that trade. Not on a wild hunch! When we enter a trade we do so because according to our evaluation of the chart, the set up, the price, the volume and whatever other criteria we’ve incorporated into that decision, this was the right time to enter that trade, fully expecting that the stock is primed to make an upward price advance very soon after we enter the trade.
If that doesn’t happen, the problem could be one of two things only. We were wrong or (b) our timing was off, which brings us back to (a) we were wrong. Why sugar coat it? Once we realize we were wrong we immediately close out the trade at the market. Think about it. If you were wrong why linger on in pain and let your stop loss take you for an even greater loss. That only reinforces what we already expected and by holding on for a greater loss makes you even wronger. I realize wronger is not grammatically correct but it does serve to drive the point home. The more you allow your losses to add up the harder it becomes to dig yourself out of the hole you have dug for yourself.
People who trade like this are afraid to cut their losses. They are what I call hopers and losers. I suppose we should be thankful for them, because without them the rest of us day traders could not make any money. There is an old adage that always seems to ring true. Most new traders are not necessarily wrong about their trades, they are usually right but at the wrong time. I’m not perfect. I have losses too. The only difference is mine are usually smaller and less painful. They happen fast. If my timing is off, I bail out immediately, many times close to break even. I stop the bleeding fast.
Once in a while I’ll bail out of a struggling position and it does an abrupt turn around and takes off without me. The number of times that happens versus the money saved is so far apart I never give it a second thought. As soon as my rules tell me to, I eject at the market, no hesitation. This is a numbers game and over time you will prevail as long as you don’t keep changing the rules with every trade. Because when you do that, your emotions become factored into the odds and everything usually spirals out of control from that point forward.
If you are tobogganing down a hill and see a problem ahead, do you jump off immediately or are you the type of person who will hang in there and go over the cliff hoping it will end well for you.
Most of our trades are entered into with an OSO order (order sends order) whereby we have set predetermined sell targets as well as our initial stop loss position. Once in the trade we move our stop losses manually one point below the low of the newly formed bar. Once our first target is hit we’ll move our stop loss to break even, then keep moving the stop up with each new bar, locking in the gains along the way.
Those day traders that do not use stop loss orders are usually concerned with their stop loss orders being visible in the market, or being caught by unusual price movements that they would normally hold through. These reasons are not enough to justify not using a stop loss, in my humble opinion. What if you have a power outage or other internet problems? The reasons for putting a stop loss in place are for more pressing. Besides what difference does it make if your stop loss is only intended as a safeguard measure? Think about it. Do you really want to stay on to the bitter end? Preserve your capital and stay alive to play another day. Remember, you are in the business of day trading. There will be plenty more opportunities
