This is a continuation of my previous entry on CFD Trading. Please take note that CFD trading is similar with share trading. So, posts about CFD Trading is relevant for share traders as well. In the entry, I said trading plan is paramount to survive in CFD Trading. A good trading plan always has a strategy on how to set stop loss(es).
First of all, what is a Stop Loss. Stop Loss is a sell order that you place below the price that you buy the CFD/Share for(for long positions) so that if the price falls to that level, you’re automatically out of the market. Before I go in any further, let me warn you that you should not get into a CFD/Share position without first figuring out where your stop loss should be. In other words, no stop loss, no trade!
Why do you need to set a stop loss order? Well, for a variety of reasons really. First, how many traders has gone through the phase whereby their share position(s) has gone down by so much and they tell themselves “It’s alright, it’ll bounce back. It’s alright, the market will reverse. It’s alright, if it goes down a little bit more, I’ll exit the market.” In a way, stop loss detach your emotions from your trading activities, which I think is very important. This is especially true for traders who still have got loads to learn, like myself.
Another reason is simply, well, who actually has the time to watch the market 24/7? Unless you’re a day trader which most of us are not, you will not have the time to sit in front of the screen all the time. Stop Loss order works as a safeguard in this circumstance.
There are a number of ways how you can determine where your stop loss should be. Of course I can’t cover all these in details for each techniques needs a chapter of its own. Anyway, here are some ways:
1. Average True Range
2. Moving Average Crossover
3. Pivot Lines
4. Support and Resistance
I’d suggest you to go through some share trading books to examine them into more details.
Another thing to point out. Some traders have a mental stop loss orders. What this means is, the trader knows where his stop loss is but he doesn’t put it through the system (i.e. didn’t tell his broker, didn’t place the order on his trading platform, etc.). The stop loss is basically in his head. I strongly advise not to use this, unless of course you are very very very very disciplined. The best way is, know where your stop loss is, and place the order through the system.
To put this into perspective, let me show you an example.
You decide to buy ABC shares at AUD1. You decide that after using the AVERAGE TRUE RANGE technique, your stop loss should be placed at AUD0.90, which in effect, you are risking only AUD0.10. Then, a few days later, the price did reach that level and you are automatically out of the market.
Yup, that simple. Trade closed. Move on to the next one.
Some just refuse to place stop loss orders. Their argument is “what if the market bounces back?”. Let me tell you this… What if it doesn’t? Are you seriously willing to gamble your hard-earned capital?
To trade CFDs or shares for that matter, SURVIVABILITY is important. You are trying to be in the market as long possible to actually reach the point of PROFITABILITY.
To sum it up. Always have a stop loss order attached to your position(s). If you can’t figure out where your stop loss should be, don’t trade.
In this post, I explained stop loss in the context of a LONG POSITION (buy low to sell high). The same concept applies to SHORT POSITION (sell high now, buy low later). The difference is, you place your stop loss order above the price you entered. For those who is confused about SHORT and LONG, disregard this, I’ll put up another post to explain this.
P.S. Once again, it is a good idea to dive into more books on CFD Trading/Share Trading to learn about Stop Losses.