Thursday, April 01, 2010

The Stop-Loss - How useful is it?

Stop-Loss is great on paper. In actual trade it is not that great. Nevertheless, if you are a trader, you must have a stop-loss. The purpose of the stop-loss is to limit your loss. The problem is to know exactly where to place it. Some people like to place it at a fixed percentage point below their purchase place. This is not the best of ways. Because each stock is different, it can't be a one-size-fits-all affair. So, before you decide where you want to place your stop-loss, the first thing to do is to figure out exactly where you want to place it. This needs plenty of intelligent hard work. As success or failure depends on it, you need to be extra careful here.

No sane person will drive a car without brakes; no smart trader will enter a trade without a stop-loss. Once you have placed a stop-loss, exercise it when it is hit no matter how painful. If you can't do that, charting is not for you. You must have discipline to succeed. Remember, the first loss is the best loss.

Where's the best place to place your stop-loss? This is more difficult that you think. Because each stock is different, it calls for a different strategy for each stock. This is where the difficulty lies. Is it just below a support level or a certain percentage point below a support level? Lets say the support level is at RM1. Do you place it at 99 sen or 97 sen? If you place it at 97 sen, does it mean that you want to be the first to sell at 97 sen or wait until 97 sen is done and then sell it at the next bid? If your intention is the latter, do be wary that from 97 sen it can go straight down to 92 sen or even lower. If that happens, will you sell at a much lower price than the price you initially set? In a case where your position is big, this happening will sent you into a frenzy panic and throw you out of all rational thoughts. You may also find that all of a sudden, there are no more buyers. This sort of thing can happen. You may lose much more than the limit you set. You have to be prepared for it. The wise thing to do is to have RM1500 when you are prepared to lose RM1000.

Another thing of concerned is that the counter may suddenly be suspended because of too much speculation, manipulation or accounting fraud. Be prepared for all these if you want to trade.

Your so-called friends laugh with you when you laugh, but when you cry, you cry alone.