Cross ref http://awanginvest.com/?p=706
IN the name of capital preservation.
I find many newbies are not too familiar with stops. I will just touch very briefly on stop loss orders.
STOP LOSS ORDER: An order placed with a broker to sell a security when it reaches a certain price. It is designed to limit an investor’s loss on a security position. Also known as a “stop order” or “stop-market order”.A stop loss order is one of those little things, but it can also make the world of difference. Every trader can benefit from this tool in some way.
Another use of this tool, though, is to lock in profits, in which case it is sometimes referred to as a TRAILING STOP.
It is also a great idea to use a stop order before you leave for holidays or enter a situation in which you will be unable to watch your positions for an extended period of time. Putting a stop loss order is a good habit which all traders irrespective of experience should have. A stop loss is your safety net, your comfort zone in taking a loss , a plan that things do not work out , an emergency exit.
It is a priority of all traders to incorporate some form of risk management as we need to respect the market and set our ego aside. If we do not respect the market, the market will force us to respect it sooner or later. This means we have to accept some risk level as well as a measure of humility.
We can consider having multiple stops like applying the Rule of 3 where we can scale out to reduce risk, by taking some profits and moving our stops, called trailing stops. Partial exits offer freedom and to reduce risk. We do not have to win on every trade. We will get wrong from time to time in the market but the best traders are those who know how to limit their losses when they are wrong. Even if we get hit with stops, we can always re-enter later when we look for the zone to re-enter.Commissions are not so expensive that we cannot afford to re-enter if we see fit. Some brokers allow conditional orders which specify multiple conditions before your stop orders get triggered.
In fact, our mentor has always recommended that newbies put a stop loss order first before even having entered a trade in order not to forget.
Stop loss orders should be seen as the tool to limit your ‘wrongs’ and by cultivating a habit of having a stop loss order, you will have the key to long term success. We will keep our losses small, especially when a black swan event takes place eg 9/11.
However, putting a stop loss level should preferably not be arbitrary. One should take into account risk reward and position sizing when working out a stop level, which you can bear.
With a stop order, your trade will be executed only when the security you want to buy or sell reaches a particular price (the stop price). Once the instrument has reached this price, a stop order essentially becomes a MARKET ORDER and is filled.
One disadvantage of the stop order is that the order is not guaranteed to be filled at the preferred price stated. Once the stop order has been triggered, it turns into a market order, which is filled at the best possible price. This price may be lower than the price specified by the stop order.
Consider these orders:
A LIMIT ORDER is an order that sets the maximum or minimum at which you are willing to buy or sell a particular stock.
BUY STOP ORDER : An order to buy a security which is entered at a price above the current offering price. It is triggered when the market price touches or goes through the buy stop price. People using a buy stop hope to gain if momentum gains on a particular instrument. If the price exceeds the price you have set, it will automatically trigger a market order.
ANA aka IDKIT