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I receive a lot of e-mails with trading questions, and lately, I’ve noticed a couple of themes. It seems that many new traders have questions about stop losses, and even the more experienced stock watcher wants to improve his risk mitigation strategy…
Here’s how to use them to improve your penny stock returns.
I receive a lot of e-mails with trading questions, and lately, I’ve noticed a couple of themes. It seems that many new traders have questions about stop losses, and even the more experienced stock watcher wants to improve his risk mitigation strategy…
Here’s how to use them to improve your penny stock returns.
These aren’t dumb questions. In fact, stop losses can be more complicated than you think. That’s why I’m going to spend some time discussing a couple of strategies today. If you learn how to manage your stop losses wisely, you could greatly improve your trading success!
Before you set your next stop loss, ask yourself the following questions:
What is the time frame for my trade?
How much risk do I want to take?
The first question is relatively simple. Are you trading, or are you investing? For a long-term investor, setting a set stop loss at 25% or so is a good idea to protect your capital. This gives your investment plenty of room to rise and fall, without stopping you out before the stock reaches its potential
If you are trading — that is, if you are planning on holding the stock anywhere from a couple of days to several weeks — the time frame is obviously short-term.
With short-term trades, I like to base my stop losses close to new areas of support. That means after a stock has made a significant move to the upside, I will look at where it is beginning to consolidate. Check out the chart I made for you below. You’ll see I’ve drawn blue and pink horizontal lines directly below new areas of short-term support:
Now on to the second question: How much risk do you want to take? If you are a conservative trader, you will want to set a tighter stop loss. I’ve drawn the conservative stops in pink…
Let’s say you bought this particular stock right at the left edge of the chart. A more conservative trader would probably set his losses a couple of cents directly below support (the first three pink lines). As you can see from the chart, the conservative trader would be stopped out of this position after the break of support at the left edge of the third pink line.
On the other hand, if you are willing to take more risk, you could set your stop a bit lower (blue lines). This would give you the chance for bigger gains. There would also be some drawbacks. Obviously, you’d be exposed to additional risk should the stock drop unexpectedly. And there’s also the time factor. You’d probably be in the position longer than you would if you had cashed out with a more conservative stop.
I think it’s also important to note that stop losses aren’t a one-size-fits-all deal. When I set them, I take into account everything from how fast the particular trend is moving to liquidity to fundamentals that might help me mitigate risk. What’s important is that you pick a stop loss level that you feel comfortable with.
Having a set stop-loss also helps traders curb their dangerous emotions. It’s tempting to let a stock ride after a bad day, then another, and even another. Your brain will justify bad decisions like these because most investors are reluctant to sell a stock for a small loss. However, if you have a firm stop loss in place — and if you are confident in your market strategies — you will have the opportunity to greatly reduce your trading losses, and improve your overall returns.
This article originally appeared on Penny Sleuth.
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