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stop loss

Why stop losses are your best bet against runaway losses

We’ve said it before and we’ll say it again: a successful trading career is built around effectively managing risk.

Traders who don’t take the proper precautions and who don’t plan for negative outcomes will quickly find themselves in situations which they’re unable to manage and escape from.

One of the most fundamental and basic tools that a trader has in order to avoid and guard against monumental loss are stop losses.

Stop Loss, Defined

Imagine you’re at the circus, watching trapeze artists swing from side to side, up and down. They fly through the air, going high and going low, always grabbing on to each other or a bar as they perform their aerial show.

They’ve practiced the routine thousands of times, and countless tries no doubt ended with someone failing and falling. But every time they fell, they landed in a net which guaranteed no serious injuries or death.

Now substitute this scene for the forex market. Prices go up and down, through mild swings and severe swings. A well trained professional will almost always pull things back up when they go down and gracefully move them from side to side as well.

But what happens when an asset starts to fall, like one of the acrobats at the circus? Without a safety net, the asset will plunge and cause great damage to the portfolio.

This is where stop losses come in.

Stop losses are a preset place where an exit will occur if a price lowers and hits the number. Stop losses are the nets that will catch your assets before they have a chance to hit the floor.

Limit Damage, Limit Emotions

After the analogy of the trapeze artists, it should be clear why many traders use stop losses in their trading.

In these articles, we constantly remind our readers about the mental aspects of trading. We’re always writing about the need to check your emotions at the door when you come to the trading table.

Traders that are driven by their emotions tend to make irrational and extreme choices that while sometimes pay off, very often lead to financial ruin.

As part of your trading plan, stop losses help to remove the emotional side of trading. They act as a hard stop that doesn’t take into account your feelings during a trade. No matter what happens or how good or bad you feel about a trade, a stop loss is mechanical and independent of your moment to moment mood swings.

No matter what you try to tell yourself regarding a price (it’s going to go up, I know it!), the stop loss will keep you in check and make sure your actions are driven by a logical plan, not a momentary emotional response.

Bottom Line

As a career trader, you should be zeroed in on maintaining a healthy portfolio and making modest, consistent gains.

Sure it’s nice to hit it big now and then, but sustained success will come from the bread and butter, day in and day out, consistent wins.

When you focus on the long term management of your assets, stop losses become an important part of the maintenance. They will ensure your work’s survival and always act as a life preserver in tumultuous time.

 

Photo by Bethany Legg

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