The golden rule of trading is: “Keep your losses small and let your profits run.” Stop losses provide a sign that it is time to exit your position as the trade is no longer co-operating with your initial view.

Watching your hard-earned capital disappear down the drain is never a pleasant experience. Most people actually quit trading after their first four or five losses. That’s why this is a game for grown-ups with a high level of emotional maturity. As long as the lessons learned from a losing trade outweigh the emotional torment, it’s likely that you will stick around long enough to learn how to trade with skill.

Setting a stop loss is an imperfect science. It is in fact one of the most frustrating areas of trading.

There are primarily three types of stop losses:

1. Initial stops
2. Break even stops
3. Trailing stops

Initial Stops

An initial stop is designed to protect your capital. Despite all of our efforts in the analysis component of trading, most traders find that they only make winning trades less than 50% of the time. Even though this sounds discouraging at first, it is the adage of keeping your losses small and manageable, and letting your profits run that will ultimately lead to the possibility of extracting great profits from the markets. If you enter a trade and almost immediately the darned thing heads downward—then you need to exit. Your initial stop loss will help to prevent your equity from washing away.

You may also need to consider a ‘time stop’. Consider exiting your position if the share hasn’t cooperated with your initial view within a particular time frame (for example five days).

Break even Stops

A break even stop will help lock in a no-loss trade. This type of stop is implemented once a trade has begun to co-operate and there is now little threat of your initial stop being hit. It’s always a great feeling when you can move your stop up to cover the costs of your transaction. At least when you’ve moved your stop to break even, there’s a chance that you will end up with a profitable trade. The goal transforms from protecting your equity to protecting your profits.

Trailing Stops

Once the share has trended strongly in the expected direction, you can follow the trend by moving your stop upwards. This will result in you exiting the trade with a profit in your account. Many people don’t set a trailing stop and watch their share spiral skywards to an amazing level, but only exit their trade when they have incurred a loss. Learn to protect your profits as well as protecting your initial capital and you’ll be well on the way to trading profitably.

Choose a technique that you feel will suit your trading plan and your personality. Commit to a method and follow it. Write it down in your trading diary. We’ll discuss these methods in more detail in up and coming newsletters. Maximise your chances of success by considering these concepts before you make your next trade.

- Louise Bedford

This informative article was contributed with the kind permission of Louise Bedford who is one of Australia’s most recognised private traders. She is also the best-selling author of The Secret of Writing Options, The Secret of Candlestick Charting, Trading Secrets and Charting Secrets.

I highly recommend them to you as they are invaluable in locating those profitable stocks.
You will find this article plus a host of other invaluable information by clicking on this link

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