Sunday, August 17, 2008

Using stops VS not using stops

There is a lot of debate out there on the use of stop order. Some people believe that stop orders get you out too early while others say that the loss prevention it provides far outweighs the possibility of getting out to early.

I believe that every trade should have a stop loss order on it. This is especially true when you factor in such things like a market crash. Now I know no one likes to think of the market as crashing. I have even heard people talk as if market crashes were unusual things. No they happen every couple years, it is a natural part of the market and you must be prepared for them.

I have seen strong up trending stocks fall 15% or 20% in one day. In these cases it would be much better to place a stop order and only lose say 5% then to not and have a 20% loss (and if the market gaps down that loss can be even higher).

Stop orders are designed for capital preservation. If you let your trades run wild you can end up losing a huge chunk of your account. Remember when trading capitol preservation always comes first.

You can ride an up trending stock all the way up as long as it doesn’t hit your stop. If it hits your stop you’re out. It does not matter if you believe that this stock is going to keep heading up, you simply cannot afford to let the stock pull back and take away your profits, or even put you in the red.

Most traders will put there stop below the trend line or below the moving average. If you are shorting you may want to put your stop above the trend line or above the moving average. The important thing is that you have an exit planed on all trades.

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