If we were to take the perspective of skill, the stock trading is much like driving a vehicle. You learn stock trading with practice much like you learn driving your car or bike. But to avoid accidents there is one thing that you cannot do easily on your own. And speed breakers are placed on public roads especially for this reason. When it comes to stock trading, it is a stop loss that works like a speed breaker for your losing stock.
A stop loss is a single most important thing in the life of a stock trader. Without it he/she is certain to drown in the bloodbaths that happen every now and then in the stock markets. Every best book I read about stock trading, every successful trader I found through my search, had always emphasized the importance of a stop loss for the long term success of a stock trader.
You Should Never Forget Stop-Loss
Even after knowing its importance it is very natural that traders ignore it once in a while. And when the hell breaks lose, which is not uncommon in the markets, the heart of the trader also breaks down. To forget to put a stop loss is a big mistake even if done only once in a while.
Stock traders develop successful trading skills with practice. Stock trading is much like any other activity. But it distinguishes itself due to the extreme risks involved as well as extreme pleasure it can give to the trader. It is much like the dangerous sports of skiing, trekking etc. People learn these things through practice much like a driver learns driving from driving his/her own car after coming out of a driving school.
Speed Breakers Avoid Accidents
You can learn to drive well with practice. But accidents still happen not because you forgot to drive well, but because a vehicle came opposite to you even when you are on your normal speed. Generally when crossing junctions, most accidents tend to happen. This is because at the junction an opposite vehicle can unexpectedly in a short span of time. And there is always a reaction time on the part of the driver that limits his/her ability to avoid accidents in such situations.
For this reason, at junctions, speed breakers are placed. These speed breakers make the driver slow down automatically because otherwise his/her vehicle is going to be damaged if continued in the same speed.
Even though we know that it is at the junctions that there is a good chance for accidents, and thus we think that we can slow down, still in reality people do not slow down most of the time. This is because the risk of accident is not certain. There is less probability for unexpected event of vehicle coming opposite. But when it does the risk is very high for the life of the driver. Hence to automatically avoid such situations, speed breakers are placed.
Stop Loss Cuts Losses Short
Similarly when it comes to your losing trades, you too should apply the rule of stop loss. Stop loss means to cut the losses when they are short. Remember every big loss first starts as small loss that you have the chance to limit. But it is hard to apply this rule because when a trade turns around unexpectedly we just can’t give up easily. We do not feel like taking a loss right now. So we let it slide giving it a chance to turn around again.
The stock may or may not turn around. Sometimes it may come back and give you expected rewards. That is what leads you to learn bad lessons. But remember that most of the time a bet gone bad, continues to get worse no matter how much you hope it will turn around.
Stop loss orders do a great help here by getting executed automatically when the stock price goes below a certain price if you have bought the stock. Sometimes we think that we will actively observe the market and sell it if it really goes down the stop loss limit price. But you should not do this. When a trade went wrong, you are most likely to be caught by emotions than by logic. Hence you should not believe in yourself. It takes sometime to get over this. Hence always apply automatic stop loss order.
Stop Loss is a Controllable Loss
You will certainly make a loss with this but it is a fixed amount that is within your control. Sometimes the thought of selling the stock for a lesser price than the current price does not let you apply the stop loss. In such times you should think about how worse it can get if you do not apply stop loss now. What if the stock falls by ten times more than the amount of loss you get by stop loss? Once you think about this, your focus changes.
To help even further, think about using that money for the next good bet. Stop the loss in this stock and go for the next best stock. Remember when you are following strong trading principles, you are most likely to win 2 out of 3 bets. If you close the current bet and gain on the next bet, then won’t you be more than happy?
Think about it during such situations. There is never a lost opportunity in the stock market. Stock market is like a blue ocean. There are always next good bets to trade. Get over the feelings of the bet gone wrong and apply the stop loss strictly.
Habit Makes Stop Losses Automatic
To make things even better build a habit to apply stop loss orders immediately after entering a stock. Many successful traders do this as a habit. This in fact works like a speed breaker for a driver on the road, because the stop loss now is much like an automatic one that is already placed without your conscious influence.
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