It’s often been said that there’s only two ways to get hurt really bad on a stock exchange, becoming caught in a”death spiral” by not using DTM: Decisive Trade Management in the means of stop loses and using a stock stopped on you. Halts you have zero control over. Death spirals are of your own making in case you don’t practice the use of stop loses.
Quite simply stated Decisive Trade Management is maintaining a stock form moving to far against you if the transaction goes bad. It’s not impossible to get 5 or 6 out of 10 trades lose money and be profitable for the internet of the total 10 trades. What you have to do is maintain your loses small and manageable and attempt to maximize you winners. This can be done with the appropriate use of Trading Stops and a rigorous discipline in using them.
It’s my firm belief that capital preservation is one of, if not the single most important thing that a dealer must focus on. It’s also my belief that it’s always better to error on the side of security or warning, generally this all comes under DTM: Decisive Trade Management.
Cease loses and the area to use them are a part of DTM
When you enter a trade, you should have a potential profit figure or profit that you aspire to obtain and a drawback loss that”you” are comfortable with when the drama turns against you. Just”you” can make that choice about what these constraints are. You’re the only one that can determine you risk tolerance and capacity to consume loses on a single trade. Factors on which these constraints are determined include the sum of money you have in your account, your expertise and knowledge of the specific stock, news or events affecting the transaction and above all market conditions and maybe others. For instance, a dealer trading a $250,000 account is more then likely better able to take a $2.00/shr hit a stock then the dealer trading a $25,000 account. Some traders will consider precisely how well they’ve done on an earlier trade or number of transactions and allow the stock run somewhat more against them if they’ve already made a couple of good trades or if they should make up for a lousy trade or two. This is quite risky. Personally, I do not like to see dangers taken in direct connection to previous transactions. I would much rather find a plan that’s in effect directly across the board. This goes along with my believing that ever trader needs to have a trading program and then you work your plan. (See Trading Strategy: Everybody Should Have One) But human nature what it is, I am sure the balancing transactions against one another is likely being done all of the time.
As a private guide, in a market with very tight trading ranges, I would think twice before letting a sock turn down by 50 cents or so. That’s a really tight stop loss for the most part; again this is flexible based upon your understanding of this stock and its trading habits coupled with your own tolerance for reduction. Within an $85 stock, 50 cents isn’t really that much, but on a $9-10 stock it is a much bigger percentage. Markets trading in tight ranges and lacking volatility make it far more challenging to recover loses when the follow through is simply not there. If the average profit in a trade is 25-75 cents, then permitting you get down on you a dollar or more will wipe out most if not all the previous gains on a couple of plays. It can take that lots of transactions to get back to even.
On the other hand some stocks may move $2 or $3 in a heart beat and reverse just as fast for $2 or $3 transfer to the cash for a total of $4-$6 or more. A $.50 cease on those will have you ceased of the trade and from the money more often then not. I suggest that unless you’re familiar with these stocks with a history of wild swings that you avoid them until you get acquainted with them.
The Trading Stop Itself
It’s the opinion of many experienced traders and one which I share, that the stop order should not really be placed. Instead you decide what price it should be and plan to place the order if and when the transaction turns against you and nears your stop price. This is called”psychological stops”. You may even go as far as having the order form all filled out and ready to execute as the price approaches your stop price. Plenty of the more recent trading platforms will make it possible for you to really put the order in their system but it’s not delivered to the market for implementation until the cost is reached.
Once you actually place the order, you lose control of you trade. Many systems don’t enable you to have two orders on precisely the identical position at exactly the identical time. If you wish to sell the stock you first have to cancel the stop and receive confirmation back before you can place a different order.
On a stock that is moving quickly against you some traders prefer to use a market order for the fast departure. I don’t like using market orders any under conditions. There are too many pitfalls involved with using market orders. Instead it is wise to use a limit price that’s significantly lower then the bidding that guarantees you get a fill.
However you chose to exercise using stop loss orders is your choice but it needs to be done. DTM with using stop orders is the only way to defend against the dreaded death spiral.