Why Stops
Whenever there is a trade that we get into,we put in a stop.The stop is that area where we say,"Enough is enough!"The stop is not put in after one has lost 80% of our portfolio and one has given up with life.I see it quite often here where one gets in on a tip because someone says so,and then take a huge loss and then say that the trade was stopped………..A stop is a predetermined level,put in BEFORE the trade is got into,the word BEFORE being an important word.I hope I do not sound lunatic when I say this:
BEFORE the trade,BEFORE the trade,BEFORE the trade,BEFORE the trade,BEFORE…………..
That stop that one has determined BEFORE the trade can be a mental stop.A mental stop is one that is not exactly broadcasted to the broker,etc………it's a technical level the break of which one does not stay in the trade any longer.Now,the irony of this mental stop is this:Please DO NOT keep the mental stop in the mind.WRITE DOWN the stop………If one entered SATYAM at 650,with a stop at 620,and a potential target of 750,write it down.
SATYAM,entry-650,stop-620,tgt-750,rew:risk=3.33:1,etc etc
If SATYAM hits 620,that is it,one is out of that trade.One either looks elsewhere,or plans a reentry into Satyam,………but what one never, ever ,ever, ever, ever, ever, ever does is to let the stops get blown through,then hold it,pray to God,run to the nearest temple,church or mosque,pray even harder,and
then try to strike a bargain with God if HE manages to pull the stock back up,beat the chest,shout at one's wife,have sleepless nights,all the while allowing it to slide,all because one wants the stock to get back to breakeven.
Trading is a profession.It's a business.It is not a place where one hopes to strike lucky,you could ,maybe once,maybe twice…….but the person who does not have a strategy ,a plan ,will in the long run come to ruin.As the famous saying goes,"Plan your Trades and Trade your Plan."
A predetermined written down stop is vital for long term success,it is vital for our mental balance,and only a disciplined trader adhering to his/her plan can see the multiplication of wealth,and a regular flow of profits.
Once again,to re-stress……a stop is planned and written down BEFORE the trade!!!!!!!
Types of Stops
There are many types of stops, few listed below.
INITIAL STOP
As described many times,this is the stop that we put in before we even put in that trade.This stop can be placed with your broker if in intradays,else,a written down exact point after which no more nonsense is going to be taken from this trade.
TRAILING STOPS
As the stock moves higher,we use trail stops.Again,there is software that does it,of which I have no idea.There are very many methods that does it using pivots,or moving averages,or two-three previous bars break method,etc.
Whatever the method used,the most important point is that once the trade moves in the direction required,the stop has to move up to breakeven first,and then upwards,till stopped.
Example
Where we should place stops ?
It's up to your comfort levels……..there are things that one can learn from books,and then there are things that can't. One can learn about the various methods,the type that you are most comfortable with,you got to choose…….
Reliance Inds was in a sideways territory trading within an ascending triangle. We got a clean breakout around the end of June,and then a pullback to support in July.We therefore enter that trade with a stop loss at the previous pivot low.This becomes our INITIAL STOP.If Rel Inds had dumped the moment we bought it and hit our Initial Stop,that's it,we are out. We look elsewhere or if Rel Inds gives us a signal for a reentry.
In this case,that entry was great.The resistance that the roof of the asc triangle provided became support………..Right,now we take out the previous pivot high of 520 as Rel Inds moves upwards.The moment we get a new high,raise the stop to the previous pivot low which was 469.That move up made a new high of 585 and then pulled back to 526. Where is our stop now through all this activity,same place of 469.Now we get another move up.The moment we make newer highs above 585,we get to do what we enjoy most……..yep,now raise stops to 526.
So on so forth………the moment we take out a previous pivot high,raise the stops to its former pivot low.We therefore use pivots as our stop areas…….. especially in position trading,this also allows us to stay in the trade as long as possible.We are basically allowing the chart to do its thing,we stand aside and go with the flow of the uptrend.
Now throughout RIL has been using that dark green trendline as its support……but around March2006,another development happens. We started going vertical,a new trendline is drawn ,the blue line,and then even more vertical,the orange line.
That break of the orange line was an area to get out of half the position.Meanwhile through the entire move from March,we apply the Channel Breakout method(I usually apply the stop to the low of 2bars ago on the weekly,and 3 bars ago if I am trading the daily charts.)In this case,RIL first broke through the trendline,and we are out half,then followed by taking out the low of 2 weekly bars ago in the week with May 11th.
That's it,we are out,this position trade is over……….in this case,RIL continued its fall,and we can all feel good about ourselves,but there are times,when we get out and RIL goes on to make new highs.Not a problem,part of trading.
At this point a question would be asked,at what place would one take profits?There is just so much that one can earn,both in terms of profits and peace of mind,by just raising stops and managing risks till a change in trend stops us out.We would probably not get out at the top,but we would take an important chunk out the trend.
Whatever type of trader one is,whatever timeframe that one trades in,a stop loss is crucial to our trading.Accepting that the trade is not going our way and reacting at the first instance keeps us,the trader,in tight control of our mind.Resultant scenarios of regret and hope and wish and all these negative adjectives that come on a negative move allowed to run against us,are dispensed away with.Stop losses placed at correct points and our discipline in honouring them is crucial to trading success.
