We need to learn how to deal with Stop Loss as it is part of our lives as traders.
Who has never taken a Stop Loss?
We’re all going to face it one day and you will only know if it was a good decision after a few days. It’s something we all have to deal with and it’s something that is often extremely unpleasant.
It is not always unpleasant because there are times when you are going to execute a Stop Loss and days later the price of the asset drops much more, so in this case, only after a few days do you realize that making the Stop Loss at that moment was a good thing.
What does it mean to take a Stop Loss?
It means that there is a probability that something will go wrong.
There is a risk that you will lose your money in a certain trade. In every trade, we have a probability of going right and we also have a certain probability of the trade going wrong. That’s the risk.
Stop Loss is a tool.
The risk we have is of losing money. Stop Loss is a tool that is used to limit how much that money is; how much the financial risk is. So in practice, the risk of trading is taking a Stop Loss. But most people don’t understand what Stop Loss is and when it should be triggered. Many people don’t understand when to use this risk containment tool and when not to.
And here’s another problem.
I see many people that don’t know the difference between a good stop and a bad stop. Learning about this will help you a lot to understand yourself, locate yourself, and effectively understand the risk of making a trade.
In short, taking a stop is understanding that a certain trade you are doing has gone wrong.
If you go into this trade thinking this is a breakout (Red Arrow on image), then on the very next bar you should understand that this is not a breakout. In practice, this means that the chance you have of taking a stop is greater. Why? Because there is a higher probability that this bullish movement will reverse. Remember that a move like this does not imply a higher continuation rate, it reduces the rate of abrupt reversal. So if the risk of buying here is high (Red Arrow on image), the chance of you taking a Stop Loss is greater. We don’t know what the next movement will be like, but it is more likely that there will be a rise here (bottom of the channel — green circles on the image).
You need to understand when the probability of getting a stop is high and when it is not.
Probability
Trading is risky. This translates into practice in understanding when the probability of getting a stop is high and when it is not.
In the example I gave above, you must understand that making the trade in each of the situations will have a different probability. The probability of winning is higher if you buy in the region where I marked the green circles, as you would be buying at the bottom of an uptrend channel. Trades in breakout regions are generally riskier, so it increases the probability of a loss.
Risk Management
This is also part of risk management. Risk management is not just Risk/Return. Risk management is understanding when it is very likely that you will get a stop and when it is unlikely that you will get a stop.
So to summarize, Stop Loss is the tool used to contain this risk. Risk and Stop are almost one thing. The risk is that a given trade goes wrong, and the stop is the tool that, if that happens, gives you a chance to protect yourself against greater losses. Minimize your loss.
We are all subject to a trade going wrong. How are you going to manage that risk, what are you going to do along the way or what are you going to do if that happens, that’s what matters. And that a lot of people don’t understand.
What Usually Happens
First: You don’t know if your stop management is correct.
Many times the person just copy and paste something they saw. So the person doesn’t know if activating the Stop Loss here is correct or not.
Second: The trade performed is wrong.
In this case, it doesn’t matter if the person tries to think if he really managed his risk well, because the trade he performed was already started in the wrong way.
That is, many people do not know if they took the Stop Loss because the trade went wrong or if they execute the trade correctly but managed it wrong.
You must understand when that Stop Loss you took was a correct stop and when you got your analysis wrong. And after this you will need to understand the basics of price movement or price action.
Here are some other scenarios:
Was your analysis correct?
Let’s assume that you did the analysis correctly, and made the entry that made the most sense and was correct at the time. But the trade went wrong, so the least likely situation happened. You shouldn’t get mad about it. This is wrong. The point here is that you correctly analyzed the market, everything was right, but the trade went wrong.
And what does that mean?
That is the least likely situation happened. You must understand that you didn’t make a mistake, you didn’t do anything wrong. “But I took a Stop Loss” — Yes, because the least likely situation has happened, and you must understand that there will always be a small chance of going wrong. It’s not your fault. This is the market.
You must know how to execute the Stop Loss.
So if the trade goes wrong, you must know how to execute the Stop Loss, regardless of whether your analysis was done correctly. The market doesn’t know who you are, and it doesn’t care about you and your money. You must execute the Stop Loss and prepare for the next opportunity.
Opportunity Cost
Don’t hold a losing position too long as this will directly affect what I call “opportunity cost”. When you do that, you’re missing out on a lot of other market opportunities. Because you have your liquidity stuck in a certain NFT, and instead you could be using this capital for new plays/new opportunities. So the longer you’re holding an NFT at a loss, only affects your Opportunity Cost.
Psychological Aspect
A Stop Loss does not define you as a loser.
Another thing you should understand is that this Stop Loss regardless of whether it was your mistake or the least likely situation in the market happened, does not define you as a loser.
A lot of people don’t want to take a Stop Loss because they think they will be “beaten” by the market. It’s just a Stop, fuck that. It is important that you take into account your capital growth curve.
Capital Growth Curve
You don’t know where that Stop Loss you took is on your capital growth curve. The important thing is to understand that within this journey the Stop Loss is part of it, it will always happen at some point. On your capital growth curve you will have so many trades there that if you place one more Stop Loss it will not change ANYTHING.
I started my NFTs journey in April 2022, I already took several stops but analyzing it from a macro view, my capital growth curve remains in an upward trend, which is the most important thing.
I know that many times it is difficult to take a Stop Loss. But understand one thing, if you are already in a position where you have to take a Stop, it means that the TRADE HAS ALREADY GONE WRONG. You’re already taking a risk you shouldn’t.
“Ah, but if I don’t activate the Stop Loss, the price can return and go up again” — Ok, but was this a good trade? You took a big risk to finish the trade at breakeven or many times with a little profit.
Evolution Of A Trader
I believe that during the life of a trader, we go through several phases. And these phases usually come in the following sequence:
1 — Loser
It’s when you are in a period where you lose more than you win.
2 — Equalizer
A trader who wins and loses.
3 — Earner
Over time he manages to stay positive in trades.
4 — Winner
It’s the last phase, where you become a winner. It’s the phase where you know what you’re doing. As a technical condition, you can leverage your risk because you calculate that risk very well.
In the end, that’s about it. We who are traders must recognize the moment to buy the risk. That’s what we do, we pay to take a risk. But this risk is calculated and we know that this risk tends to be paid overtime for the result that we tend to have when we buy this risk. In the future, I may post new content just about this topic. But I thought it was important to mention this during this article.
Conclusion
Stop Loss is not bad. It shouldn’t be avoided at all costs. On the contrary, you will use it to protect yourself from major losses. The trade has already gone wrong, you just have to decide what to do.
Stop Loss is a tool that you will use to prevent the risk of positions that went wrong from breaking you.
Previous Stop Loss decisions don’t define you. As long as you make good trades, you tend to have good results, regardless of the result of the previous trade.
Forget previous Stop Loss decisions. The money is gone. It’s not yours anymore. There’s nothing else for you to do. So what can you do instead? Search for new money. Search for a new entry. Search for a new play. During day trading, forget the previous Stop Loss, you must go after new money, next play. Wait for a good entry, and hit it, so you can take advantage of a good opportunity later.
So remember:
If the outcome of the next trade is unrelated to the Stop Loss you just took, the money you will make on the next trade is unrelated to the money you just lost. Forget what happened. At the end of the day you stop and analyze the trades you made that day. See if you didn’t make a mistake or if the less unlikely situation happened. If a mistake occurred, understand how to fix it, so in the next time you can avoid it happening again.
Written by: Kaleve
