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Stop loss is a vexatious word among traders in commodity and capital markets.
What the lover of stop loss do is to take insurance to his investment and he survives in trading.
Placing a stop loss is a trading strategy to minimize the risk in trading and protect the investment .The psychology behind the detestation towards stop loss by traders is the fear of it getting triggered when the market is moving up and down.
The main reason to hit stop loss frequently in trading is out of ignorance as to where the stop loss is to be placed and how to find the actual stop loss level.
Before placing a stop loss, we should understand some points for successful trading. The investor should realize the inherent risk -reward ratio in trading, study the measures to minimize the risk and the methods to invest in an investment vehicle.
Following factors should be considered while placing stop loss:
The risk-taking ability in stop loss depends upon the nature and ability of the investor. An investor who is able to take more risk in trading can give more room for the movements of the commodity but it should be proportional to the profit from it.
If we are entering into a trade, we should take some precaution to save our money. Nobody likes to make a loss. So stop loss is a unique strategy to protect our capital from excessive loss.
The trader should be the sole decider of his position and he should be willing to take full responsibility of his trade. That is, instead of blindly following the trade recommendations and rumors from the market, he should study the market and make his own judgement in trading.
Most of the traders are making loss from overnight positions, which are not protected by reasonable stop losses. Another reason for making loss is to take an intra-day position carrying over it to the next day without exiting, if the position moves against his expectation. Entering into an intra-day trade and changing it to overnight position without proper stop loss can ultimately end in huge loss.
So before entering into a trade, the trader should decide whether the trade is intraday or overnight, and then should place proper stop loss to protect the investment.
You need to have basic knowledge for placing the appropriate stop loss. For this, you can seek advice from a technical analyst, or can place stop loss on percentage wise. Checking the historical volatility and past price movement data are also helpful for finding stop loss levels.
There are two kinds of stop losses - Fixed Stop Loss and Trailing Stop Loss.
Fixed Stop Loss involves placing a stop loss at a fixed support level. In the case of Trailing Stop Loss, a stop loss is placed at a fixed support level, which is adjusted according to the anticipated movement of the commodity.
According to the nature of movement of the market, stop loss can be tight or liberal. In a most volatile market, more leverage or more room for the underlying commodity to move is ideal.
If you think it might possibly move up but will definitely drop if it slips below a certain price, then a tight stop loss strategy is a must. On a quick day trade, tight stop loss strategy is a good idea.
If you are trading in a bearish market and you are trying to go long, tight stop losses are absolutely necessary. You also need to take a tight stop loss strategy if you are trading in a choppy and unclear market.
Biju Thomas is Head, Commodity Online Research. He can be contacted at research@commodityonline.com