Home Finance How To Use Stop-Losses To Improve Your Trading

How To Use Stop-Losses To Improve Your Trading

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In my column this week I would like to discuss ways to begin trading. But to start, let’s first define what trading is. It is any type of transaction where the duration is usually less than 3 years. This a definition that the South African Revenue Services uses, and I agree.

 

It does not always include the geared products like FX (foreign exchange), CFDs (contracts for difference) or futures (see the sidebar). It is more about the duration of how long a position is held and when it comes to the three-year rule it means that many people that think of them themselves as investors are actually traders, because they are holding for under three years.

 

One of the first things that a new person to trading has to understand has to do with you will not make money fast. There are many things you first need to learn and understand, and similar to any other type of skill, it takes time and patience to master. In general, my advice will be to new traders that they probably won’t make money within the first year and maybe even two, and to rather set goals of breaking even in this period. The protection of your capital at this point is important, because if you lose it, you will have start over again.

 

 

How To Use A Stop-Loss

 

It becomes easier to protect your capital when you use a simple tool known as: the rigid stop-loss. This will be the predetermined level where you have accepted that a trade is no longer working. As soon as a stock has reached this stage, you exit your position without hesitating. The issue with stop-loss is that in many cases the traders ignore this important rule because they are too afraid to take a loss or to admit they have made a mistake. Yet this is the wrong way to deal with trading. Any of the trades that you do enter are merely about probabilities and even the successful traders are often wrong at least 50% of the time. But when your trades that are profitable are bringing in more money compared to the ones that are losing money, you are winning.

 

To take it one step further, it is unwise to use loss or profit on any of the individual trades as a metric for your overall success. Even when you are doing everything right, the trade might be one out of those 50% that results in loss. To explain it further, you may be doing everything right, but you are stopped out over a loss. How are you able to decide when a trade is not good, after you have obeyed all the rules?

 

A far better way to measure our success as traders is to make a decision on what the perfect trades look like followed by trying to execute more perfect trades according to Ultimate Stock Alerts. The list on what will make perfect trades does not include loss or profit, but would rather include the questions like: Was the size position right? Was I able to wait for the confirmation? Did I have my exit-strategy ready before entering the trade? Did I stick to my exit-strategy? I personally use a list that contains 7 points and my overall aim is pretty simple: to achieve 7/7 for every trade.

 

One of the other essential aspects about a stop-loss, is where you have placed it. In most cases, traders are placing it way too close to an entry. An example of this is 3% away from an entry on the stock, which has a daily move average of just about 2%, and the true range average of close to 5%. These values are telling you that a 3% stop-loss will hit almost even as the share starts to move towards your direction, in association to the duration of this trade. In this case you would need to lower the trade size and then move your stock-loss to about 8%, from the entry, which will offer you with additional wiggle room.

 

Smaller trades is an important point to start at for the newbies. You may feel tempted to use your entire capital on one trade because you feel confident about your decision. As I mentioned before trading has to do with probabilities and any of the trades can be losing or profiting. You have to ensure that you are able to survive from the losing trades.

 

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