In the stock picking business, there is no trading crystal ball. You will never get to see next week's newspaper today, no matter how good you are or how hard you try. You can be one of the best stock analysts out there and still be, at best, treading water with your real trading with real dollars in real time.
Why is that and how can that be true? You see, the losing positions have to be handled in some manner efficiently or they will eat away so much of the profits that it may actually make it an almost impossible task to make any money. And you WILL have losing positions and losing trades. Everyone does and no matter how good you might be, you will still make some blunders from time to time.
Let's look at some of the ways to manage your trading to minimize those losing trades :
The Stop Loss Order
One of the first ways you will likely hear about is to use a stop loss order on all of your stock trades. Right off the bat, you will not be liked very much by your broker. That is at least if you are still using a broker who is also making recommendations to you about what to buy. The "traditional" brokers hate these type of orders and some will actually argue with you about using them. They want you to always "buy" into the idea that everything
they recommend will always go up and keep you there. Over the last several years, with the raging bear market eating away at virtually everyone's portfolio, this has dissipated somewhat. But it still seems to be a sticking point with some.
When using a stop loss order, you can use a couple of different methods to determine exactly where to place your stop. You can use a set percentage amount, say 5% or 10% that you are willing to risk. If you do your own analysis and are confident in it, you can use a particular price that you derive from your analysis as a possible reversal or turning point and place your stop there. Personally, I like the later and have found it to be more in "tune" with the price movements than just a standard and fixed amount or percentage.
But if you do not do your own analysis, this will not be an option for you. By using stop orders, you will limit your potential loss on every stock trade you make while, theoretically
at least, allowing for unlimited profits on each trade.
In options trading you will have to figure out a ballpark number to use as a "mental" stop. Very, very few brokers will allow you to place physical stop loss orders on option positions. Due the way they are priced and sometimes fluctuate, you will have to pick a price to exit the position and move on. If you do your own analysis, then follow the underlying and when it moves through a price point where you feel you should exit then sell the position regardless of the option price.
You have to be careful in the placement of your orders and be willing to accept some lost profits because you placed your orders in the wrong place and were stopped out at the wrong time.
In the next post we explain another way to limit your losses while still preserving your good trades.