Online Investing & Online Stock & Share Trading: Difficulty in Taking Stop Losses in the Market

This is an extract of an article which 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."

I added my 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&page=1#pid2132

Daryl Guppy's Newsletter Tutorials in Applied Technical Analysis (http://www.guppytraders.com) has been voted no. 1 in Australia by 'Shares' & no 4 in the world by 'US Stocks & Commodities'.

Jason Mitchell is a full time trader. His tools and strategies can be easily applied in the stock & share markets.He is the founder of the popular trading newsletter,the StarTrader Report. For more information go to http://www.StarTraderReport.com

With Jim Berg, John Atkinson co-authors the Investing Online Newsletter & Online Trading Report;In Home Study Courses and Portfolio Management Tools available at http://www.sharetradingeducation.com

His Ebook the Atkinson-Guppy Articles is a collation of trading articles written for Daryl Guppy's newsletter which focus on exit strategies; money & risk management & original material on trading strategies for Share Purchase Plans, rights issues, avalanche selling & much more.

Now available from http://www.sharetradingeducation.com with a special promotional savings of 30%. A FREE SAMPLE chapter may be downloaded by registering in the Free Downloads section at this site.

---

Discover the Biggest Trading & Investing Online Mistake

Any online investor / trader seeks an excellent off or... Read More

Acapulco - The Stock Market Dives

There is a famous cliff on the ocean in Acapulco... Read More

Planning Your Dive and Diving Your Plan ? Trading!

A colleague of mine just returned from a scuba diving... Read More

Investment Attorneys and Garbage Stocks

How is it possible that trash Companies are posting less... Read More

Stock and Fund Dividends

When is a dividend not a dividend?The latest thing "conservative"... Read More

Are You A Stockaholic?

Today's society gives special recognition to alcoholics, sexaholics, binge-aholics, shopaholics,... Read More

Choosing A Fund

For years I have been saying you must have a... Read More

China Syndrome

There has been great condemnation recently because China has been... Read More

The Seven Mistakes All Novice Traders Make and How to Correct Them

We learnt the following the hard way! If any of... Read More

Stock Market System ... ONLINE STOCK TRADING ... Beyond Day Trading Basics & Tips

Day trading is all about making buy and sell decisions.... Read More

The Elephant

Four blind men were asked to give a description of... Read More

How to Short Stocks? How to Make Money when Your Stocks Go Down by Shorting

The stock market can present you with a lot of... Read More

Bottoms Ups

If you have talked to a stock broker or financial... Read More

Duct Tape

Did you run out to buy that duct tape yet?... Read More

Bargain Basement - Finding Stocks That Go Up

Have you been listening to the talking heads on CNBC-TV?... Read More

How to Evaluate Load vs. No Load Mutual Funds

If you have been dealing with mutual funds for any... Read More

What is the Most Important Indicator of All?

Most stock market traders have a favorite technical indicator.The one... Read More

Quality Investment Information: Standing Firm In the Face of Opposition

THERE'S SOMETHING TO BE SAID FOR standing firm in the... Read More

Market Psychology

Today we are inundated with tons of information about the... Read More

On Line Stock Trading: Small Cap & Micro Stocks Go Up and Down - How Can You Profit?

Success in small cap & micro cap stock trading like... Read More

The Golden Goose is Sick

It is finally catching up with them. The brokerage companies... Read More

Jack and Jill

Jack and Jill went up the hill to fetch a... Read More

Some Good News for A Change

Before we get into all the good news out there,... Read More

No Load Mutual Funds: Boost Your Portfolios Returns

Investors who exclusively use broadly diversified, no load mutual funds... Read More

Prospering with Mutual Funds: How Anyone can ?Afford? an Investment Advisor

Recently I was invited to appear on a live CNNfn... Read More

Selling

The stock market has been going up for more than... Read More

Trend Trading - Trading Stocks Using Technical Analysis and Swing Trading Strategies

Peter is a professional trader, Paul is not. Peter has... Read More

Long Term Financial Vehicles

Investing in long-term financial vehicles give you the most gains... Read More

Top 25 Growth Funds

On Monday, November 25, 2000 Investor's Business Daily listed on... Read More

Is Active Trading The Answer?

One of the main reasons many of us get into... Read More

Red, Green, Yellow - or - Stop, Go, Go Very Fast: Which Describes Your Online Trading?

Ever notice how behavior in one area of life can... Read More

Money, Insanity and Wall Street

Money: the most charged word in the planet. It means... Read More

Different Types of Mutual Funds

This is a guide to the different types of mutual... Read More