Art of Trading: Risk Management — Stop Losses and Final Thoughts 3/3

Understanding Risk for More Profitable Trades.

Please Note: This is the third section in a series entitled Art of Trading: Risk Management. For a more thorough understanding, I recommend reading the first and second section of this topic entitled Trading Mindset and Portfolio Position Sizing

Stop Losses

How do you mitigate risk with a trade on the line?

Stop losses are an important part of risk management and trading plans because they limit downside potential. For a single trade, limiting loss enables you get up and fight another day. If you don’t set stop losses, you diminish your capital and limit your ability to make new trades

PSA: If you ever speak with an investment professional, never say the words “stop loss”. They will immediately assume that you don’t know what you are talking about. Too many people think that the “stop loss” will stop losses from occurring, which is false. Investment professionals get blamed for this error on the investors part and it is an ugly conversation.

Stop losses are a mental price point at which you will longer accept the loss from a trade. It can be accomplished through manual entry of trades or a stop limit (or market) into the market. The purpose of this is to either limit loss or to assure a gain.

The reason I say “mental” is a comment specifically focused on the highly manipulated, unregulated crypto-markets. Often times, large players in a single market will make massive movements to shake out “stop limits (or markets)” and force buys or sells. This is called “stop-hunting” and happens frequently in unregulated markets. These normally coincide with bullish movements in the market and should be carefully considered before acting on it.

Stop losses are normally applied to our first and second categories of investment purpose covered previously: shorter and longer-term capital appreciation. Major positions, like coins kept as a store of value, normally won’t have stop losses because the purpose is considered to have a significantly longer time horizon. By contrast, shorter term holds need much tighter protection against downside risk to allow for maximum capital protection.

Stop losses should always be determined BEFORE you enter a trade. On any single trade, at what point will no longer accept loss? This is normally a calculated decision based either a pre-determined percentage amount (for scalpers) or the application of trend lines and indicators (for swing traders).

Stop losses can also be used to guarantee a profit. For example, if a trade you make has risen in value, to guarantee profit you can set stop losses under the price so that if it drops, profit is locked-in.

Final Thoughts

Loss happens, the greatest traders all have losses and sometimes losing streaks. However, if you carefully stick to your trading plan and assess all your risk before entry, you are better prepared to accept that loss.

Bad trades are a fact of life, and for all the good trades you see publicly acknowledged, there are several unpublished failures. For every successful trader crowing on social media, there is a trail of mistakes and catastrophes. However, the key to being successful is to minimize bad trades. If you create a trading plan and follow proper risk management, then there are no bad trades, there are just “less successful ones”.

If I make a trade and my stop loss kicks in, I do not consider it a failure. I consider it as a good trade on my part to acknowledge the downside potential. Do not get upset over the loss and move right along. The only trades I consider “bad” are the ones that I realize I made a mistake. Maybe I didn’t set a stop limit or failed in some way that I either should have known or easily could have avoided, that’s a bad trade.

Prepare a risk management plan before every trade, identify the mindset, the purpose and how to limit your downside. Then place your trade.

“Take calculated risks, that is quite different from being rash.” — General George S. Patton.

Jack Donaghy

If this has been of assistance to you, please consider a tip. Thank you for your consideration.

BTC: 3BMEXBAxgLtMMzq89tDC3Gzi2MbwAjoEvQ

ETH: 0xa27eaa97713d776994cb3969c3ba8f8f5a1ff9d3

LTC: LYq7m98VQfxNQ2qMMKKWeaBW7WsCUH6NGm

Disclosure

The opinions and investment strategies of the author are their own and not to be construed as investment advice. With any type of investment, the potential exists to lose some or all of your investment. The author makes no guarantees of gain or increased profit and cannot be held responsible for losses incurred.

Cross Posted @ Medium.com.
Credit to Pexels.com for photos.