Why Do We Recommend the Stop Loss Order?
First of all, the beauty of the stop-loss order is that it costs nothing to implement. Your regular commission is charged only once the stop-loss price has been reached and the stock must be sold. It's like a free insurance policy!
Secondly, but most importantly, a stop-loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks; we believe that if we give a stock another chance, it will come around. This causes us to procrastinate and delay, giving the stock yet another chance and then yet another. In the meantime, the losses mount....
No matter what type of investor you are, you should know why you own a stock. A value investor's criteria will be different from that of a growth investor, which will be different still from an active trader. Any one strategy may work, but only if you stick to the strategy. This also means that if you are a hardcore buy and hold investor, your stop-loss orders are next to useless. If you plan on holding a stock for the next decade there is no reason to place a stop. The point here is to be confident in your strategy and carry through with your plan. Stop-loss orders help us stay on track without clouding our judgment with emotion.
Finally, it's important to realize that stop-loss orders do not guarantee you'll make money in the stock market; you still have to make intelligent investment or trading decisions. If you don't, you'll lose just as much money as you would without a stop-loss, only at a much slower rate.
Conclusion
The 2% and the 6% rules of thumb are highly recommended for all traders, especially those who are prone to the emotional pain of experienced losses. If you are more risk averse, by all means, adjust the percentage loss limiters to lower numbers than 2% and 6%. It is not recommended, however, that you increase your thresholds--the pros rarely stray above such potential for losses, so do think twice before you increase your risk thresholds.
A stop loss order is such a simple little tool, yet so many traders fail to use it. Whether to prevent excessive losses or to lock-in profits, nearly all investing styles can benefit from this trade. Think of a stop loss as an insurance policy: you hope you never have to use it, but it's good to know you have the protection if you need it.
As a subscriber to our newsletter services, you do not have to worry about where you should be putting your stop-loss levels. All our Newsletters carry appropriate stop-loss levels suitable for their respective methods of trading. (tradingpicks.com)
