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When And When Not To Use A Stop (Page 1 of 2) |
A stop loss order is simply a trailing "safety net" that you can attach to a stock buy. The purpose of a stop loss order is to keep you from being "trapped" in a stock that falls a ton of points. It is all done electronically and it is both easy to use and quite mandatory in our opinion.
Many times you will hear ..Know your exit before you go in. On the downside though. For instance there are going to be times when you make a trade and it goes against you. That is normal and it happens to every trader. The difference is that if your trade was fundamentally flawed (you bought a stock thinking it would make a short term run but it fizzled out instead) you should have a set predetermined price that you will let that stock fall to and ..you are out.
For instance lets say we think the XYZ company is going to fly because of a hot news release and we buy 500 shares. but almost instantly the thing starts backing up and soon we are down a couple points. Do you hold or do you sell? Since we were looking for a run up over the news, and it was greeted with selling...it was probably best in this instance to sell out and take our loss and move on to a winning trade. But what if you buy a great company and because of market conditions or whatever..you are faced with your stock falling on you? That is where stop loss orders come in. Let's say we bought into XYZ and XYZ was a great company . We think that it has the ability to go for many points and history shows us that it already has in the past. So we buy it BUT we attach a "stop loss order" to it. What that means is that we are going to tell the broker just exactly how far we are going to let XYZ fall before we sell and take our loss. Let's assume XYZ is selling for 100 dollars a share and we know that it often bounces up and down about 2- 3 points in a normal days range. We might want to tell the brokerage that we would like to sell out at say ..96 dollars per share if it falls that far.
That is a stop loss order and it is attached to your account electronically. They will ask if you want that order good for the day, or good till cancel which simply means do you want the sale to fire off if the stock hits 96 dollars today only, or for the next 60 days (that is about the range of a good til cancel order). Let's say we tell them it's a "GTC". So from the time you bought XYZ , and for the next 60 days or so if XYZ falls to 96 or lower it will trigger your sell program and you will take your loss.
The use of stops on every trade is suggested. The reason is quite simple. If you know the "average" daily range a stock seems to travel in and it falls out of that range...who knows where the bottom might be. A stop loss order will sell you out at a loss for sure, but it will save you from the nightmare of coming home to find your stock got slammed and now you own it but its down 30 points. Now for some things that a stop loss order will not solve.. first if your company announces something bad before the bell and it gaps down 15 points on the open, your order will fire, but it will sell you out at that low. Sometimes in that instance it is better to cancel your stop loss and hope that it rebounds. ( the thinking is like this... the order couldn't save you, so since you have two choices sell it at that low or hold it hoping for some type of nice rebound..often its better to hold it.)
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