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Why stop losses are such a vital part of your investment strategy

by , 21 October 2014

Last week, markets across the world were extremely volatile. Concerns over growth of the world's economy dented investor confidence. The swings on the market were hard to keep up with.

It's when the markets are like this that risk management becomes ever more important. When markets are trending upwards, it's easy to forget about vital strategies such as stop losses.

So why are stop losses so important? And how can you use them?

Read on to find out…

The role of stop losses

When you invest in shares, risk management is crucial. If you don’t take measures to manage your risk, you’re increasing the chances of losing substantial amounts of money in the market.

Stop losses do two important things, Dr David Eifrig in Income Intelligence explains…

Firstly, using stop losses means that you know how much you could potentially lose on an investment.

For example, if you invest 4% of your investment capital into one stock and use a 25% stop loss, you’re only risking 1% of your capital on that investment.

This means that you know how much you could potentially lose. And this should stop you worrying needlessly about your investments.

Secondly, it stops any mind games. Emotions can play havoc with your investments. Listen to your heart about your investments and chances are you’ll lose money.

Selling at a loss is never easy. You hope that your investment might recover. But waiting for an impending recovery has the potential to make matters worse.

Using stop losses removes emotions from your decision making. It forces you to sell a position.

Using a trailing stop loss

Instead of opting for a fixed stop loss, of say 25% below your buy in price, it’s a good idea to opt for a trailing stop loss. This means if the share you buy climbs in price, you’re locking in profits along the way.

As the price of a share rises, your stop loss rises with it.

So there you have it, why stop losses are such a vital part of your investment strategy.

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Why stop losses are such a vital part of your investment strategy
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