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Did you know: You can blow your money using a stop loss?

by , 28 March 2014
Did you know: You can blow your money using a stop loss?
“I entered an ALSI trade the other day at 40,000. I wanted to protect my portfolio, so I set a stop loss at 39,910. The problem is, the market went below my stop loss (39,910) and I LOST even more than I should have. Please explain why?”- Roxy

Every good trader and trading book tells you how crucial it is to put in a stop loss when you trade.

But if you don't know HOW to put a stop loss into your trade, you might as well take your hard earned trading bucks and chuck them in the bin!

Today I'm going to show you how to use a stop loss correctly, so you don't lose more money than what you can handle.

How you can blow a ton of money trading using a stop loss!

Let’s use the ALSI (JSE All Share Top 40 shares) index as an example, so you can see how you can lose even more money by putting in a stop loss.

Say you go long (buy) the ALSI at 40,000 and you’re only willing to risk 90 points. So you place your stop loss at 39,910.

You get into the ALSI trade and immediately, it turns against you.

Half an hour later it trades at around 39,920, which is 10 points before it hits your stop loss.

By now being in the trade, you start to feel jittery and less confident.

But then, a big news event, such as the NFP (Non-Farm Payrolls), comes out with numbers worse than expected.

So the ALSI gaps (jumps) 10 points below your stop loss, without hitting it, from 39,920 down to 39,900 and continues to tumble.

Your stop loss has been triggered and your sell order has been placed. But the problem is, your order for 39,910 has not been met yet.
So you’re not out of your losing position.

You start to panic big time and decide to lower your stop even more.

But the market keeps plunging down. And by the time you’ve adjusted your stop loss, the ALSI is down over 100 points away from your initial stop. 

So now, you’re at the point of giving up and you quickly phone your broker, to get you out of the market ASAP.

Your broker gets you out, but only 130 points below your original stop loss..

After that one trade, you feel like you’ll never want to trade again.

You were willing to lose 90 points but you ended up losing 220 points.

I don’t want that to ever happen to you.

And that’s why today, I’m going to show you two steps on how to put in your stop loss (trigger order) correctly so you can avoid making this common trading mistake.

Step #1: Put in your trigger price when you go long (buy) the market

You’ll put in what’s called a trigger price.

A trigger price is basically the price at which an order to sell you out of your trade is triggered, BELOW what the market is trading.

So this means, if the market trades at the trigger price or your desired stop loss level (39,910), then it will trigger your limit order. That brings us to step 2: The limit order.

Step #2: Put in your limit order

The limit order is the price that you will be willing to sell down to. And if you’ve set your trigger price, this offer to sell will be entered into the market when your trigger price is, well, triggered.

NOTE: When you’re long in the market, I suggest you put your limit order below the trigger price.  But you need to know the liquidity of the market to know where the best price for you should be.

If the market gaps below the limit order then, your offer order will sit in the market but will not get you out! So make sure you set your limit
The limit order is also known as the stop limit order, order price or a slippage order price.

Depending on what broker you use, you’ll see one of these names.

And so, the price you’ll enter as the limit order, will be a number of points below your trigger price (stop loss price).

But let me explain this better with our ALSI example!

You went long at 40,000 and you put your trigger price (desired stop loss level) at 39,910 and you put your limit order price at 39,900 (which is below your trigger price).

This is a 10 point difference between the trigger price and the limit order price.

So should the market gap – jumping past your desires level – below 39,910, anywhere above 39,900 (limit order price), you’ll get out of your trade!

The maximum you’ll lose is 10 points more, if the ALSI jumps your stop loss price to 39,900.

That 10 point difference is known as your slippage, because it’s 10 points that would have slipped away from your stop loss level.

If the ALSI market trades anywhere between these 10 points, you’ll get out of your trade at that price.

With a fast falling market, you can be very happy that you took an extra 10 point loss if the market hits 39,900, rather than losing over 100 points more than your stop loss level!

Before you get all excited to go trade and use a trigger order, you need to know this!

Watch out for this common trading mistake!

Choosing your slippage price will vary depending on what instrument you choose and how liquid the instrument is.

So, make sure you know the market you’re trading and you know more or less the spread differences (between your bid and offer prices) and the gap potential.

For example, with illiquid penny shares, big gaps are far more common than with highly liquid blue chip shares and high liquid indices.

So the trick is to know the liquidity and the spreads of the instrument you’re trading.

This little technique could save you from blowing huge money unnecessarily on trading mistakes.

Always remember,

"Wisdom yields wealth"

Timon Rossolimos
Senior Editor: Trading Tips 
Head Analyst: Red Hot Storm Trader
Author:           94 Top Trading Lessons of All Time 


Did you know: You can blow your money using a stop loss?
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