Trading and Investing

Deciding a STOP LOSS

The first thing a trader ensures before taking a trade is deciding the stoploss. For some it is the 20DMA, 100DMA, Support level, rising trendline, resitance level, pivot point or some other of the many technical indicators. Few traders go for a % stop loss, that is, exiting the trade if the price moves a fixed % against you. For some it is 1% or 2% or as big as 10-12% in positional trades. But which is the best way of putting a stop loss?

Losing is frustrating

What is a stop loss?
Assume, you have purchased 100 shares of Sterlite Industries at 102 per share which brings your cost to 10,200 (excluding brokerage). Now the price will wither move above or below your price. It could go up to 150, giving you 5000 as profit or it could go down to 60 leaving your capital invested to around 50% of what it was. So, while making a trade you have to decide your risk in the trade. Assume you can risk 500 total loss on this particular trade, so as you are carrying 100 shares, you can take a risk of 5 per share, so you place you decide that once the share goes below 97 (102-5), you will close this trade.
Another way is, suppose the 20DMA is at 98.3 and so you decide, once the share moves below the 20DMA, as it is showing signs of weakness, you will close this trade.

So, stoploss is that price level where you square off your position in any investment or trade where the price moves against you and results in a loss for you. It is used as a tool to stop losses from becoming big and eating up a substantial part of your portfolio.

Various types of stop loss and how can you use them:

1. Loss per trade capacity:
In this method, you decide your loss taking capacity per trade and accordingly decide the price where you will book your loss and square off.

2. Technical Indicators:
In this method, you look at charts and decide the level where you will book your losses based on technical indicators such as moving averages, momentum oscillators, supports and resistances.

3. News Events:
This is usually when you speculate a forthcoming event which could decide the future course of action for a stock or asset and once the news come out, you exit if the news you feel is negative for your profits.

Traders have always agreed that many times, the trade hits their stop loss, they square off and later it goes on to hit the target. This is really very frustrating! You are drained out, you curse your luck and next time, you won't book your loss the moment your stop loss is hit. And then your loss widens, and all you do is again curse your luck! Agree? I do. It happened to me in my early years. But that was the best lesson learnt back then.

How to squareoff once a stop loss as been hit:

I personally always give my trade some space to move below my SL. Keep in mind, "SOME SPACE".
While looking at charts for really volatile stocks, I have noticed many of them, break technical supports during trading hours and some how manage to close above the supports. In suck stocks, I place my SL based on closing price.

Let's look at an example of Ajanta Pharma:

Ajanta Pharma

Ajanta Pharma is one stock I have actively traded over the last one year in and out. It is a traders favourite stock! Ask me where will it be 1 year from now, I will be as blank as the person who never heard of stocks!

Look at the number of instances where the stock has broken 20DMA and closed above it, look at the times it has closed BELOW the 20DMA and gone on to rally! How did I trade these?

In my recent trade (still open as on 4th June, 2013) I have placed a SL at 900 though the 20DMA is at 912! 900 is a short term support which I believe should be held intraday! But if around closing, the stock is below 20DMA, that is between 900 & 910, I will book my loss. So what if the stock continues rising like before?

Simple, I will buy it once it is above the 20DMA again. A fresh entry.

Assume you purchased 10 shares of Ajanta Pharma at 940, stoploss at 910 closing basis, and the stock moves upto 990. What will you do? Book profit here or still hold for a further rise?

In my case, I will book 30% at the current level, and hold the rest with a trailing stoploss ABOVE my cost to keep my profits protected. If the stock falls, I will book another 30% at say maybe 965 and the rest at 940. If the stock was giving decent profits, I WILL not book a loss. Maybe I'll re-enter again but for this trade, something is better than nothing.

The best way?
Their is no such BEST WAY. Every trader has his own comfort level. Practice and design a system which suits you well. The important part is: FOLLOW THE RULES STRICTLY. 
Never get emotional and keep holding your losses. Be quick to book a loss and let profits keep running.

To debate, suggest and present your views or any other queries, drop in an email on my id:
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