Last week we discussed the benefits of using the correct charts, i.e. perspectives in our lives and how zooming out from the current situation often allows us to see the solution in a different light, which otherwise would appear as noise.
Read time: about 2 min.
This week we will focus on one of the most critical aspects of trading without which it is considered fatal even to enter any market.
What is Stop Loss? The maximum amount of money traders are prepared to risk or lose in every trade. Assessing the correct Stop Loss forces the traders to calculate the risk to reward balance before taking a position. It is a double edged-sword. If the Stop Loss is too large and if the market moves against, then the trader risks to lose a lot more than they may have an appetite for. On the other hand, if the Stop Loss is too close to the price, then it may take the traders out of their positions too soon and leave the money on the table. However, it also saves traders from losing their shirts.
For instance, a buy position is taken at $100 with a Stop Loss of $95 and a Profit Target of $110. If the market goes against the buy price and dips to or below the Stop Loss, the trader will be taken out of the position with a loss of $5 + commission and other charges. It is a loss of +$5 but a loss nevertheless. However, without a Stop Loss, if the market had continued to go down, the trader would have been exposed to more significant loss or even a margin call. Here a loss of $5 seems acceptable. There is a frustrating flip side to this scenario, where the market would take the trader out at $95 but would swing back to go higher and even beyond the traders’ Profit Target of $105. Here, the trader was stopped out prematurely and left the money on the table.
This is one major struggle every trader goes through at all times. It is a fight between greed and content.
Where else do you see this?
One evening an old Cherokee told his grandson about a battle that goes on inside us all. He said, “My son, the battle is between two wolves inside us all. One is Evil. It is anger, envy, jealousy, sorrow, regret, greed, arrogance, self-pity, guilt, resentment, inferiority, lies, false pride, superiority, and ego. The other is Good. It is joy, peace, love, hope, serenity, humility, kindness, benevolence, empathy, generosity, truth, compassion, and faith.” The grandson thought about it for a minute and then asked: “Which wolf wins?” The old Cherokee simply replied, “The one you feed.”
The self-reflection to arrive at the right balance to be a successful trader can be extrapolated to other aspects of our lives. It forces us to reflect on what is more important for us. Winning big and losing big or being willing to take a smaller profit and have the capital to fight another day – i.e. conquer our greed and make progress at a steady pace.
Life is full of choice too. It’s up to us what we consider most important before making a choice. By laying the concept of Stop Loss in the background, we will be better prepared ahead of time. Whether it’s our health, relationships, finance or career, this concept can help place us on the right side of every equation.
What’s our Stop Loss around a relationship that is on the verge of going south? How much longer are we willing to wait to make peace before it’s too late? How much longer will we wait to call our loved ones before the relationship becomes irreparable?
Have no time in our lives? How much longer are we willing to wait before realizing that we are squandering our precious time on things that are not moving the needle?
Going for a party? If we know our limits, then we will control the number of drinks before making a display of ourselves. How much more of those yummy butter tarts will cost us extra pounds?
Planning to get ahead in your career? How much longer are we willing to wait to learn some new skills, retool ourselves before we become obsolete?
Struggling to make the dollars stretch till the end of the month? How much are we willing to splurge on non-essentials before we can no longer afford the essentials?
If our trade is hitting the Stop Loss often, then its a sign that the trading plan and strategy is not going well, and it’s time to make some adjustment. As traders, we, too, see pieces of evidence within and around our lives going against our plan. It is time to adjust the Stop Loss to stay put or cut the losses and try again.
Thank you for sharing some of your precious time with me each week.
Until next week.