Online Investing & Online Stock & Share Trading: Difficulty in
Taking Stop Losses in the Market
This is an extract of an article by John Atkinson, co-editor of
the world famous 'Investing & Online Trading stock market
newsletter' at www.sharetradingeducation.com.
This article was first printed in Daryl Guppy's Newsletter
Tutorials in Applied Technical Analysis on 26 March 2005 and is
reprinted here with his permission
A stop loss is a predetermined exit point. When a trade is first
planned, the stop loss is designed to protect the trader's
capital. The exact price of the stop loss is the result of a
relationship between the maximum level of risk as determined by
the 2% rule, the logical support levels on the chart, and the
amount of capital the trader wants to allocate to the trade. By
varying these three figures, the trader is able to reach an
ideal trading solution that controls risk effectively.
A stop loss order should always be constructed at the same time
that any trade is planned or entered. Disciplined stop loss sell
orders are the key to long term trading success.
The new chat room Stockmeetingplace.com has an educational bias
where traders from around the world come to exchange ideas, swap
exploration formulas and discuss trading techniques.
Many topics are covered and for the benefit of readers who may
not have read the following, this article is based on four posts
on Stockmeetingplace which were recently provided by two regular
contributors to this newsletter and myself on the subject of the
difficulty in taking stop losses.
This topic was introduced by a new trader Jim who wrote:
Okay I'm going admit it, "I find it hard to act on stop losses".
I know I'm not the only one.
Many possible reasons ...I'm comfortably ahead this year
anyway...the companies are fundamentally sound with good
prospects...the price decline defies common sense (this is a
common thought). I've pondered on this for some time now.
Anyway, I know I've got a problem that could bite me hard if the
market turned nasty. For those of you that have been here but
overcame it, please share your thoughts on how you did it.
In response, John Atkinson replied:
"In Daryl's first book Share Trading he uses the analogy for
wannabe traders of learning to put down notes on the footpath
and have someone pick them up & walk away with your money.
During the tech stock run traders worldwide felt they were
invincible as stocks soared at an incredibly fast pace. During
those times we found it easy to sell out at losses when you were
making up for it on other profitable trades.
Then one week the party was over - and all of a sudden its not
any fun anymore as you see red on any screen you look at - and
no more green up days
First of all regret hits you - wishing you hadn't listened to
that broker who told you to hold - regret you hadn't got out
sooner - regret you hadn't acted on your stop (if you set one in
the first place) or not bought such a large position or too many
positions or had actually taken the time to get some education
on technical analysis, psychology and risk management in the
first place
This then moves to hope - the BHP approach - Buy Hope and Pray -
you find yourself looking at the charts or screen hoping the
share will turn around - believe me the share can't hear you -
it doesn't care about you or your hope - it always did and
always will respond to supply & demand and if no-one wants it ,
it's headed South.
Then fear really hits - gut wrenching fear as you see your
capital decimated - 20 years of working multiple jobs to get
ahead & most of it all gone in months ....... sleepless nights
for weeks then months .......And you still have to try &
function at work by day when you've been pacing the house night
after night - your mind goes, your memory goes, your reasoning
goes - and our waterfront home went.
And all of that can be traced back months previously to a series
of small decisions that evolve around getting the right
education and developing discipline for correct position sizing,
capital allocation, setting your initial stop, moving up
trailing stops and exiting your stops when they're triggered.
Hope this helps you in what you consider now to be a dilemma. I
also hope this helps you decide whether trading is actually for
you or not and please realise it's okay to say no and seek your
fortune in other endeavours, in which case we applaud you for
your decision.
I mean this with sincere conviction - trading is not for
everyone and sorry to be appearing tough on you but acting on
stops is tough - and the alternative is much tougher, believe
me."
To this Jason Mitchell added
"Well done on being honest. I think as you say many people do
have trouble acting on stops. I would like to tell you there is
a nice simple way but I think for many people it takes losing
money. It did for me anyway. This is because of our beliefs.
I noticed in your post you wrote "the companies are
fundamentally sound with good prospects...the price decline
defies common sense (this is a common thought)"
I am assuming these are your thought processes. Thought
processes are generally underpinned by our beliefs. I have no
trouble acting on stop losses because I have lost money in the
past not doing it. My belief is that working on fundamentals and
common sense loses me money while acting on stops helps make me
money. Your belief however may be that the fundamental opinion
of a company is meaningful and that price will come back.
I am not saying you are wrong and the others are right. Every
body has a different way of trading. Many fundamental analysts
have no time for technical views - if they make it work that is
fine. I believe using technical analysis is a numbers game.
Minimise losses and put the balance of probability on your side.
In order to do this stops are generally needed.
Changing beliefs for the most part (I think) comes from our
experiences. For example I love dogs but if I got mauled
tomorrow by a pit bull I may be less caring next time I see one
running across the road... Maybe this answer is not what you are
looking for but while ever someone is trying to adhere to
another person's belief when it doesn't seem right to them,
there will always be trouble maintaining discipline.
The only suggestion I can make is extensive research on your
approach. Seeing factual results can be hard to deny especially
when there is a repeated pattern that becomes visible. This
could be done through back testing but this is more difficult
with fundamental and technical combined. Hope this helps in some
small way. I admire your honesty."
Daryl Guppy added his perspective on this subject with the
following:
"Consistently exercising stop loss discipline is the greatest
challenge and barrier to successful long term trading. Our
desire to avoid experiencing the pain of losing is hardwired.
Once you have created a discipline to take a series of losses
you tend to find that another set of inhibiting factors start to
creep in. At first they are special cases, Later they become the
'normal' reason for not acting a stop losses and the losses grow.
I do not think there is a single, or simple, solution. The
solutions we use to force ourselves to act on stops change over
time. We need to be alert for the need to change and the more we
can read about the different ways that others resolve this
problem, then the better the chance we give ourselves of finding
a solution that will work for us.
The foundation is accurate trade planning and good records
showing how a trade failed. Look for the patterns as Jason
suggests, and then develop strategies to block the losing
behaviours. This may mean not taking particular types of trades
because they always 'blow up."
Jim's response to these replies may be read at
http://www.stockmeetingplace.com/forum/viewthread.php?tid=471&pag
e=1#pid2132