When you’re day trading for a living, it’s important to understand that you risk becoming vulnerable to sharp movements in price as the trading day unfolds. And when you’re trading on margin, you’re even more vulnerable. Many day traders protect themselves by using a stop-loss. A stop-loss is an order that a trader places with a broker to sell when a security hits a specific price. There are several advantages to utilizing a stop-loss:
Minimizes Risk: Stop-losses allow traders to set a limit to what they are willing to lose.
Eliminates Emotion: Once the price is hit, the stop-loss order is executed… regardless of how the trader feels about the stock. Using a stop-loss is great for traders who tend to stay attached to losing stocks in hopes that they will rebound.
No extra costs: A stop-loss order doesn’t cost anything extra to implement.
Limits Maintenance: If a day trader can’t constantly monitor a stock, a stop-loss guarantees that losses won’t mount.
Locks in Profits: A stop-loss can be set at any price. If a stock is rising, a trader can put in a stop-loss order at any point below what it’s currently being sold at. A stop-loss can help assure that the trade remains profitable even after a reversal.
So how do you determine a stop-loss? It all depends on your strategy and on how you perceive the stock’s past performance. The goal is to pick a stop-loss price that allows the stock to fluctuate but protects against downside risk. A 5% stop-loss might not be the best strategy for a stock that fluctuates 10% over the course of any given week. An active day trader might prefer 5% stop-losses, while a long-term investor may be comfortable with 15% stop-losses.
Whatever your trading style, a stop-loss can help. It’s a free insurance policy that protects against devastating losses. If you’re looking to learn about more this strategy, no to mention plenty of others, 101investing.com has education programs that get results. We’ll show you how to become a day trader and develop a trading strategy that works for you!