A stop-loss order is a trade order to close your position when the market moves against you.
Some traders don’t believe in using stop losses. These traders have been stopped out right before watching the price move in their favor again.
They remember these painful experiences. They remember them too well.
As a result, they believe that having their stop order in the market makes them vulnerable to “stop hunters”.
Other traders do not have a one because they just do not want to lose. Most of these traders are no longer trading.
You must have a working stop-loss order in the market.
#1: There must be a price at which your perceived trading edge is gone
This is true for technical traders.
If you believe that stop hunters are chasing you, then place your order further away. Just put it somewhere.
For instance, if you bought a stock at $45 and was aiming to sell it at $50 because of a perfect Hikkake pattern, what reason do you have to keep the stock if it has fallen to $20?
Is the trading edge you perceived from the Hikkake pattern is still valid?
(Fundamental traders might be better off with a mental stop. This is because their perceived advantage is not based on price levels alone.)
#2: A stop-loss protects you from your worst enemy
Your worst enemy is yourself. And that is because you don’t want to lose.
A stop-loss order forces you to take losses.
We don’t like to take losses, but taking losses is part of profitable trading. It is a game of probability, and not of certainty.
Having a stop-loss order working in the market enhances your discipline to take good losses.
(If you are taking too many bad losses, you might be over-trading. Learn how to stop over-trading.)
#3: You cannot put in a stop-loss order by blinking
This is particularly the case for day traders.
If you do not have a working stop-loss order in the market, when the market gets volatile, you will not be able to send the stop-loss order from your brain to your broker by blinking at the falling prices.
Mental orders will not do.
As with everything in trading, there are exceptions.
- Die-hard buy and hold investors probably won’t need a stop loss order. Technically, these traders have a stop-loss at zero dollars.
- Some options strategies limit the risk to the initial outlay. Hence, options traders may not need a stop order to protect them.
- Traders who know the fundamental conditions that erase their trading edge, but they are unable to relate a particular price point. For them, they could exit their position once they recognize that circumstances have changed.
In essence, a stop loss order reminds us that we, as traders, are fallible.
Learn more about placing stop losses: