Stop losses. One of the most hotly debated areas of trading. Should you have them? Where to place them? Why are they needed?
To make it clear, I trade with stop losses. They are large, I hate them, but they are there strictly for emergencies. I just don’t trust myself to bail myself out in a disaster. Over 15 years of trading has taught me that even if I should know better, I don’t.
Emergency stops are also handy for other things like technology failures, broker issues or surprise stripograms in the middle of the trading day.
A typical discussion on stop losses with a beginner trader
I can paraphrase one of my most common discussions with students and beginner traders like this:
TraderJoe: Adam … do you think the EUR will rise today?
Me: No idea.
TraderJoe: What about tomorrow .. you think it will rise tomorrow?
Me: Well there is some US data tonight, and a full moon, and I think I might be going through manopause. So … no idea.
TraderJoe: How about by the end of the week?
Me: TraderJoe Are you holding a long position?
TraderJoe: Do you think it will go to 1.2300 by the end of the week?
Me: You have a long position don’t you? You know the worst thing about manopause? Sore nipples.
TraderJoe: What about 1.2290?
Me: What was your stop loss traderjoe?
TraderJoe: I don’t use stop losses, I don’t like to confine my trade
Me: Well there is a fair way to go before we see 1.2300, need to see if 1.2200 holds for now. You know pure bees wax does wonders for sore nipples, way better than any nipple cream?
TraderJoe: So you think it will rise right?
Me: My nipples?
So on and so forth for rest of the week as prices make up their mind.
This is usually followed by a conversation around a week later:
TraderJoe: Hey Adam … remember me?
Me: Sure, and my nipples are way better thanks, African fire bug urine did the trick.
TraderJoe: Remember that EUR long position I had last week? I closed it this morning at +10 .. see that is why I don’t use stop losses, it’s all about the freedom man.
Me: Well done. How did your other trades go?
TraderJoe: I couldn’t take any other trades …
Now TraderJoe convinced himself stop losses of any sort aren’t needed. But what is the catch with the above scenario for the beginner trader?
Missed trades. Missed opportunity. Missed education.
While TraderJoe did close in profit, it took him out of the market for a week for a +10 return. That’s a week of no trades, no wins or losses, and no advancement on his trading education. All for ego.
For traders starting out with a small, leveraged account, margin calls are but a click away.
A large losing trade locks you out of the market as you don’t have the margin for any new trades. Now you miss a multitude of other opportunities for profit and education.
To trade without a stop loss, tiny trade sizes are essential to trade your way out of trouble, and keep options open for other trades. But with a small account, this is not possible as you can’t take a trade small enough.
Ask yourself one question
Assuming you don’t like trading with tiny positions, and agree you need a stop loss, how do you do it?
I ask myself one thing when placing stop losses:
At what point is my trade no longer valid?
You place trades on your belief price will move in a certain direction. You should be able to visualize it in your mind. If you can picture the trade going right, you must be also able to picture it going wrong.
The place that is not in your profitable trading picture. That is the place for your stop loss.
Often our losses are our biggest educational wins.
How do you place your stop losses?