In this latest video on trading biases we're going to look at stop losses, what are
they there for, and why still there's so many people
have problems with them. Hello I'm David Jones from Capital.com and this is the
latest of our videos where we take a look at trading biases. Now our trading
platform has an algorithm that will try and examine client behaviour, and see if
clients have picked up biases or bad habits and hopefully try
and nudge them in the direction, like these videos, to try and hopefully correct
those biases. This time around we're going to take a look at stop losses. This
is one of two videos that we're doing on stop losses. First of all what we're
going to look at [is] what are we actually trying to achieve by using a stop loss,
and then also why do so many people either not use them or place them
incorrectly? Let's take a look. So let's take a look at some of the reasons why
people might not use stop losses. First of all, what is the purpose of a stop
loss? It's to have a predefined level of risk when you enter a trade. A stop loss
also enforces the discipline of exiting the trade when the stop is actually hit.
If you placed a stop loss with your broker it's automatically executed when
the market gets to that level. Of course the purpose of a stop loss is all about
keeping risk to a manageable level. So no one trade should do significant damage
to your trading account, it's keeping losses at a sensible manageable level. So
this all sounds very logical but why do some people not bother selling stop
losses? Conspiracy theories; I have heard a few over the years some people think
if they put their stop-loss in the market, then the evil market will move
and take their stop-loss out, before going exactly the way they thought it
was going to be. This is clearly nonsense but it's one reason why some people
won't place stop losses. It's highly unlikely that you're trading big enough
for the market to get pushed to find your stop-loss you're just a very
small speck when it comes to trading markets. Plenty of people don't have a
trading plan so they'll think "well I want to buy gold" but they don't have a
plan for getting out, if their view ends up being proved wrong.
So the stop-loss doesn't really exist in their mind because they don't have that
plan in place. Perhaps the biggest reason is an inability to admit when
they are wrong. Nobody is right all the time when
trading and a big part of trading success, perhaps the biggest part, is
keeping losses to a manageable small level and when you're winning trades
move in your favour letting them run far enough to make a decent profit. So to be
able to do that you do of course need to admit when you're wrong and that's where
stop-loss' come in. But if people have a problem in admitting they're wrong on a
trade, then, one way of avoiding that responsibility is not setting stop
losses. Let's take a look at some real examples of where not setting stock
losses could really hurt your trading. We could pick up on lots of examples, but
I've picked a popular market here; the Dow Jones. So the Dow Jones - this is in
early October - the Dow Jones is trading around about 26,500
and you may decide the market is going to rise - it has been rising we've
been in an uptrend, the RSI down here is oversold, so you may decide to buy at
26,540 because you think the markets
going to rise. But let's say you have a problem admitting when you're wrong, so
you decide not to place a stop loss. Let's jump forwards in time. Not long
after the trade was placed, the market sold off incredibly heavily. It sold off
by around about 1000 points. So you bought in at 26,540 - or
our trader with no stop-loss bought in at 26,540. Maybe a sensible
place to have a stop loss would have been under the recent lows; around about
26,200, so a risk of in this example about 340
points. You can see by not having a stop and just sitting there -
maybe like a deer frozen in the head lights -
the trader ended up with a much bigger loss than that person would have been
banking on. Stop losses get you out of extreme moves when you're wrong, so you
come away with a manageable loss, and you don't sit there with a market going
quickly against you in a major direction - racking up much bigger losses than you
were planning. Of course you can use stop losses in both directions; if you're
selling short. Let's take a look at Brent crude oil here. It was trading just
below $80 a barrel you may have thought "well actually this market is going to run
out of steam, $80 is too expensive, I'm going to sell short" so you may have a
stop-loss at $81 a barrel and if the market gets
there it'll take me out of the trade. Let's say we did a trade with no stop-loss.
Selling here we are at 7966, what happens next? So you can see this is
where we were looking at the market initially at 7966, it started a move
that extended for another $6 about $6.5 from where the short
would have been put on. If you had a stop at 81
we'd have been taken out there for a small loss in this example. But if we
didn't have a stop loss and just stuck to the position, hoping the market was
turned going to turn around, we ended up racking up a much much bigger loss that
we could have avoided by using a stop. So the stop loss is there to manage risk,
it's to get us out of a trade when our opinion ends up being proved wrong. It's
a way of admitting we were wrong and if we're placing the stop-loss with a
broker that's something that happens automatically. Next time around we're
going to take a look at how to set more effective stop losses. There's of
course a whole host of other content on our YouTube channel, where we have
various market outlooks, for all sorts of different markets out there, and also
looking at trading strategies. But from me, David Jones, and Capital.com for this
latest session on trading biases we'll wrap things up there.