The Stop Loss
The Stop Loss
“Stops” are simply orders to exit a trade at a predetermined price. Let’s say that you think the price of a certain commodity is going up, so you want to buy a contract (go long).
The stop loss is an order that is opposite of your entry order. In other words, if you go long on a contract, you would place a stop (an order to sell the contract and exit the trade) somewhere below your entry price. Let’s look at a generic example of going long on the following chart to show you what I mean:
Since you expected the price to go up, you “bought” a contract to “go long.” You make money when the price goes up. But if the price goes down, you want to protect yourself. You want to limit your losses. In this example, you risked $516.20 because you entered long from 7127 and your stop loss (your sell order) was at 7076. This means if the price went down to 7076 or below, you would be “stopped out” with a loss of $516.25 because if the price dropped and “hit” your stop, your contract would be sold for a loss at that price.
THERE ARE CERTAIN TIMES THAT EVEN A STOP LOSS WILL NOT PROTECT YOU.
As an example, let’s say you were long the Silver market from $14.00 and you had a protective stop at $13.75. This means if the market drops down to $13.75, you would be stopped out with a loss of $.25, or $1,250. Remember that a $1.00 move in Silver is Worth $5,000. But what happens if you go to bed one night, wake up the next morning, and the price of Silver opened at $13.50? It never “hit” your stop (it opened below it) in this case and you were stopped out at the opening price of $13.50, for a loss of .$0.50, or $2,500! Don’t ask me how I know! It’s just one of the risks in trading and something you need to be aware of. There’s not much you can do about it, either. It probably won’t happen to you at all, or not very often anyway, but you should be aware of it. (Remember my promise not to “sugarcoat” anything). When a price drops or rallies below or above the closing price, it’s called a Gap. I have a lesson on Gaps later.
Every time you place an order, you should always place a stop at the same time. Never trade without a stop loss of some kind. Later in the course, you will learn to use options as a stop. You don’t want to put your stops too close to your entry price, because if you do, you will get “stopped out” during the normal day-to-day price fluctuations. I’ll cover the best place to put your stops later in the course. Right now, I just want you to be familiar with how they work.
IMPORTANT!
A good rule of thumb is to never risk more than your margin amount. Stops are just one way you can limit your losses when trading. We will cover other ways a little later.
Notice on the following chart, March 2019 Beans, the price “gapped up” on the open the next day on the open. It closed at 9.0750 and opened the next day at 9.2975 which is a difference of $1,137.50. If you had been short this market and had your protective stop just above the high of the current day's bar, you would not have been stopped out there. You would have been stopped out on the open the next day incurring an ADDITIONAL loss of $887.50 in "Slippage". We will cover Slippage in more detail later. For now, just be aware that just because you have a protective stop at a specific price you might not get stopped out there and lose more money than you had planned. Of course, Slippage can work in your favor also. Like on the chart below, if you had been long that market, it would have jumped up to $887.50 in your favor on the open the next day.
As mentioned, the stop loss is an order that is opposite to your entry order. In other words, if you go long on a contract, you would place a stop (an order to sell the contract and exit the trade) somewhere below your entry price. Let’s look at a generic example of going long on the following chart to show you what I mean:
There are MANY other kinds of trailing stops that you can use with the software. This is only one of them.
IMPORTANT!
In the following video, I talked about using a $300.00 trailing stop. As I completed the video my stop had locked in $430.00 in profits. I noticed that just a few minutes later my trailing stop had jumped up again and was locking in $470.00. You can see this in the video below. I thought it was worth pointing this out
Click on the video link below.
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