Knowing When To Get Out – Tips and Tricks That Only The Experts Know
Stop-losses are one of the best ways of protecting yourself when things go wrong. Good traders get out when their loss limit is reached without emotion or second thought. This is one of the main reasons why they are good – they take their losses, swallow their pride and live to trade another day. A stop loss is a point where you no longer wish to be an owner of the stock and ideally is a point where the character of the stock has changed so much that the original reason why you entered the stock in the first place is no longer valid. There are different methods of setting stop-losses.The major method is to base it on the share price though other methods may involve getting out once a time limit is reached or when a certain proportion of your account is lost. Even when considering the share price method, there are several ways of calculating stop losses. The way you chose must be compatible with your system and you will need to back test your system considerably before you decide on a particular method. Some examples include:
- Using a percentage retracement – i.e. having the stop loss a certain percentage away from the low of the day
- Basing stop losses on major resistance or support levels found by analysis stock charts
- Using various indicators such as ATR (average true range) to take into account the daily variations in the fluctuation of a share price
Your stop-loss method is essentially an extension of your personality. You need to be comfortable with your trading method or otherwise you will not stick to it! One of the best methods is to use a stop loss method that is free from emotion and is mathematically calculated. This way, there can be no room for emotion to creep in. Generally these types of stops can be calculated by a computer to make things even quicker! Before you enter into a trading position, you must know where you will be placing your stop loss and your method needs to take this into consideration. Never enter a trade and then consider putting in the stop loss as an afterthought; you must always know where to place the stop loss before you even enter the trade.
This is another key for a successful trader. When you have set your stop loss you can then consider trailing it. This means that if, for example, you bought the stock at $10 and it is now $11 and you set your initial stop loss at $9.50, you can now consider increasing the stop loss to say $10.50. This means that you have effectively locked in some profit by “trailing” your stop loss even if the trade starts going against you. You can never lose on this trade! The final rule is that you must never trail your stop on the opposite direction. This means that it is perfectly acceptable to increase a stop loss if the stock is going up, but you must never decrease your stop loss even if the stock starts to go down. Doing so will expose you to even more risk and is a sign of an undisciplined trader.
Example Of A Simple Stop Loss Method
As mentioned above, ATR can be used to calculate stop losses. Many computer programs such as Metastock will calculate ATR for you and save you a lot of time. Every day, almost all volatile stocks display an intra-day shift in prices. In other words, there will be changes during the day when the price will shift upwards or downwards from the original opening price of the day. There will be an opening and a close price as well as a high and low for the day. Most of the time, these values will be different from each other.
To add more complication, different days have different intra-day ranges. Additionally, different stocks have very different ranges. The result of the daily change in prices is that if you set your stop loss within the intra-day range, you will almost certainly get kicked out of the trade too early. If we take an average of the intra-day range of say the past 10 days, we arrive at a figure that gives us estimation as to how much, on average, we can expect the stock to vary during the day. The idea is that if we place the stop loss a certain proportion away from the low of the day, say, one and a half or even two times away, then we can be reasonably certain that the intra-day variation will not prematurely kick us out of the trade unless there has been a serious change in the characteristic of the stock. ATR is, in principle, very similar to the above explanation (though technically speaking, there is a slight variation in the calculation that we will not go into here).
We therefore want to place the stop-loss a fixed multiple of ATR away from the low if we are to stand a good chance of not getting stopped out too early.If for example the intra-day low of stock XYZ is $10 and the ATR is found to be 20c, you would want to make sure that the stop loss is at least 20c lower than the low of the day or, in this instance, at least $9.80 (or preferably lower).
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