Stop Loss Order

Stop Loss Order

The Trader's U E-Letter: Issue # 152

Wednesday, September 14, 2005

The Stop Loss Order: The Deciding Factor in Trading and Investing

by D.R. Barton, Jr., Chairman, Trader's U

I needed to pop over to the grocery store for some milk, bread, bananas and Diet Dr. Pepper. Just the necessities. I was in a hurry, so I wanted to get to there as fast as possible.

I came to the stop sign at the end of my street and blew right through it. When I hit the four-way stop at the next intersection, I just kept going. Everyone else has to stop, so there's no need for me to hit the breaks.

Then came the stop sign at the only major intersection between me and the grocery store. I took my foot off the accelerator, quickly looked, and then charged right through it.

I got to the grocery store in record time. "No one could have done that any quicker," I thought smugly to myself. It was, I admit, a bit exhilarating.

I hope that most people reading this are appalled. I hope you're thinking, "What kind of bonehead would run through stop signs, risking life and limb, just to get to store a little quicker?"

And I hope you apply that same indignation directly to your own trading and investing, which brings us to today's topicthe stop loss order.

The Stop Loss Order: Job #1 For Every Trader and Investor

Of course, I didn't run every stop sign on my way to the store. (How can I enjoy all of that tasty Diet Dr. Pepper if I'm laid up in the hospital?)

Running all of the stop signs is certainly the quickest way to the store. But it is also the most dangerous. If any driver continued to run stop signs, he would get everywhere very quickly - until a collision wiped him out. In the same way, taking trades or making investments with no stop loss order is the easiest - and most dangerous - thing you can do.

Anyone can buy a stock or other investments. But if you do so without setting an exact point to get out if you're wrong, you're just waiting for a bus to blindside you when you least expect it.

Top traders and investors all agree that their first job is to manage the risk of the trade. They do this by setting stop loss orders. Most of you are familiar with this concept. But how many of us set our stop loss points and get out at that point every single time it is hit?

Do This Every Time or Nothing Else Matters

I just had the pleasure of teaching at a workshop on Advanced Trading System Design with Dr. Van Tharp, and system guru Chuck Le Beau. When I was covering a section on stop loss orders, I made a statement which I believe to be one of the ultimate truths of trading and investing:

"If you cannot consistently set and honor your stop loss points, nothing else that you learn this weekend will matter."

That is true for the attendees at that seminar and for all of us reading this letter. If you blow through your stop orders without honoring them as THE steadfast tool for guarding your equitythen every strategy, fancy system or newsletter you try will fail. It's that simple.

If you have trouble setting and keeping stop loss orders, here are some guidelines that should prove useful:

  • Never take a trade or enter an investment before you determine a firm stop loss order. Make this your steadfast rule. If you know your ultimate "get out" point before every trade, you will get two benefits. First you know that your equity will be protected. And second, when you know your risk amount, you can make better decisions about how many shares or contracts you can buy or sell.
  • Write down your stop loss point. If you have trouble keeping your stop loss points, try writing each one down - before you enter the trade or investment. This simple act reinforces your commitment to action, should you need to get out. Research on many different topics has shown the power of writing down your commitments. Try setting up a simple log sheet where you write the basic information from every trade or investment you make. Include the date, time, entry price, direction (long or short) stop loss point, final exit, and reasons for entering and exiting the position. If you do this for every trade, you'll be amazed at how much you learn about your trading process, and how much better you can be at honoring your stops!
  • Think about losses as business expenses, not as times when you were wrong. No one gets every trade or investment right. Treat the times when you get stopped out as a normal cost of doing business - not as a personal affront to your trading and investing skill. This will help you pull the trigger, get out when it's time, and move on to the next opportunity.

Making stop loss orders a routine part of your risk management is just as important for traders and investors as it is for drivers.

The Chart of the Week

Traders U Chart of the Week

Crude oil futures have traded significantly lower since our article on September 1 called that near-term top.

Now crude prices sit at a very important point - if they break through this area where prices have reacted before, we could see a continued pullback to the mid-$50s. If they react upward, then this could be seen as just a short-term pullback on the way to new highs. For now, a close below $62 should be viewed as significant.

Great trading,

D.R.

D. R. Barton, Jr., editor and founder of Trader's U. Barton is chief operating officer and risk manager for the Directional Research and Trading hedge fund group. He is also one of the top-rated national speakers, lecturing on stock and futures trading, along with other key strategies for investors.

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