Where Should I Set my Stop Loss Orders? // Stop loss explained, Stop loss stocks, Stop loss options Trading and investing limit order welcome to another episode of looking at the markets with
David Moadel all right today's topic is where should I set my stop loss orders
not everyone uses stop-loss orders
if you are going to use them I hope that you're not setting them randomly you
need to decide before you buy a stock or option where you'll sell if the trade
goes against you as well as where you'll sell if the trade goes in the right
direction
a good route a good rule of thumb is to give three times as much upside Rome as
downside Rome
so before making a trade
you'll first need to decide where your stop loss will be this will be a number
slightly below the purchase price
here's the purchase price and here's where you put your stop loss order the
distance between the purchase price and the stop loss order will represent the
maximum amount of money that you're willing to lose on the trade
it should wrap a skinny it should represent a small fraction of your total
trading account a reasonable guideline for most people would be five percent of
your trading account or better yet less than that
ok if you want to make it one percent that's great two three four five percent
at most anything more than that and you might be taking unnecessary risk
depending on the size of your account and your situation of course but five
percent or less on any trade is a pretty good safe guideline for most traders in
most situations at least in my experience at the time of purchase use a
stop loss order to set this limit
so when you make the when you make the purchase go ahead and at the same time
or right afterward set that stop loss order by doing this you'll be
establishing your maximum loss on the trade which is this amount from here to
here
you'll also want to place a limit order at the price where you'll be selling if
the trade goes in the right direction which is right here that's where you'll
sell and that's a limit order if things go your way
which hopefully they will so you take the distance between the purchase price
and the stop loss order
I'm sorry purchase prices here and the stop loss order you take that distance
and you multiply it by 3 and then you add the purchase price
that's where you'll set your stop loss order up here
in other words the distance between the purchase price and where you'll sell if
the trade goes in the right direction so the distance from here to here i should
say is three times as large as the distance between the purchase price over
here and where you'll sell if the trade goes against you
so this distance is three times as large as this distance
to put it yet another way let your winners run three times as far as your
losses with this three to one ratio
you're cutting your losses short and letting your winners run
so let's go over an example let's say you purchase stock and the stock ticker
is XYZ
so you buy it at two hundred dollars so you set your stop loss
let's say at 195 all right so you're willing to you decide beforehand that
you're willing to lose five dollars on the trade because that's a small
percentage of your account
five percent or less now you'll set a limit order to sell if it reaches - 15
that's five dollars of room to the downside and three times as much
yes that's fifteen dollars of room to run to the upside
then you can just leave the trade alone if you want to and let your conditional
sell orders do all the work for you
sooner or later you'll either profit fifteen dollars to the upside or lose
five dollars to the downside on the trade
the toughest part for many people emotionally speaking the toughest part
is having the tenacity the stick-to-itiveness to let the winners
run
so let's go back to that same example you purchase stock XYZ at two hundred
dollars
set your stop loss at 195 and then you've got your limit order to sell if
it reaches - 15
you have to be willing to honor both of those conditional sell orders resist the
temptation to take profits on the way up
yeah resist the temptation to take profits early when it hits a to a way to
10 to 12 etc let your winners run all the way
sure the trade could turn around and head back toward 195
that's a possibility that you'll need to accept beforehand just accept that
yeah it could run up to in this example it could run up to
- 10 to 12 even - 14 and then head red but right back down and take out your
stop loss and one at 195 that could happen and you'll want to accept that
possibility before you even make the trade for many people the best approach
is to set the conditional sell orders after making the purchase of course and
then walk away for a while
let the stock go wherever it wants to go let it run its course
after all you have no control over that aspect of it
this hands-off approach can reduce the temptation to meddle with your
predetermined conditional sell orders by adhering to this three to one ratio
you'll have big winners and relatively small losses
this means that after you make a large number of trades and assuming that you
use small position sizes for each trade like I told you to do
even if you're right only a third or thirty three percent of the time at
least theoretically you could still you might still at least break even and
hopefully you'll be right more than thirty three percent of the time on your
trades at least I hope so
so used properly stop losses can add a measure of safety and enhanced
profitability to your trading system
this in turn can lead to more money in your account and just as importantly a
better night's sleep
if you need more help with this or with any aspect of trading or investing feel
free to contact me
my email address is David Modell @ gmail.com
hope to hear from you soon talk to you next time