The Five O’Clock Trader

How I Learned the Uber-Important Value of Always Using Stops When Trading

If you have been trading anything — stocks, forex, precious metals, or maybe even rare Pokemon cards (okay, probably not Pokemon) — then you have encountered the term “stop loss.” Maybe you understood it when you first heard the term, maybe not. Maybe, like me, you simply ignored setting and using good “stops” because you were always in such a hurry to get in on the next good trade.

Let me tell you — I would have become a profitable trader much more quickly if I had listened to wiser heads who said, “Always use stops. Always!”

A stop loss is simply an indicator of the pre-determined amount that you are willing to lose if your trade turns bad and goes against you.

There are very few chances that you get to take in life where you can completely control the risk ahead of time — but trading is one of them. When you stop to think about it, it’s a concept that makes great sense and offers you the chance to sleep really well at night. But, far too many people (including me, for a long while) simply refuse to use this little safety valve.

It’s like there’s a voice that comes into your head and says, “Hey, you know that trade is going to work; why don’t you give it just a little more room?”

You kind of hate it that you've already put so much money into the trade, and you know that if it would just turn around and go the other way, you’d get all your money back and then some! To make matters worse (which I have done far too often,) you are tempted to add a little more money to the trade so that you can “make up” some of the ground you've lost.

The problem is that, statistically, trades just don’t turn around and “go the other way” until most traders have exhausted all the reserve funds they have in their account — and they lose much more than they were planning to. In fact, the scrap heap of “busted trades” due to lack of a stop loss would probably circle the globe several times if you stretched them all end to end, or something like that.

I was proud of the number of times that I picked the winning direction in a trade — often selecting profitable trades 80% of the time, or more. But still, my trading account kept going down, down, down.

How could I be so right, and still end up on the wrong end of the deal?

The answer: I didn't pick losing trades all that often, but when I did, I lost WAY too much money on them. I became so enamored of my “winning percentage” that I was afraid to get out of a losing trade.

One day, I took a look at my trades for the past month and figured how much money I would have made if I had set some consistent stops of about 100 points (pips, in forex terms.) After the floor rushed up to meet me and I picked myself up, I was astounded to see that I could actually have made more money by going ahead and losing on those trades much earlier!

I don’t like to lose — but I have now traded long enough to know that losses are simply a part of winning. When you take some risks, sometimes you will get stung. The key is to not get stung too badly on any one trade. Believe me, you will live to trade another day — if you will use your stops!

I’m going to be putting out a brief series of “how to” articles very soon, and one of the sessions will be on how to select and set an appropriate stop for your trades. I’m thinking of titling it, “How to Pick a Great Loser,” or something like that. Look for it here on Medium.com.

Also look for the website Fiveoclocktrader.com (coming soon) and don’t forget to hit me on Twitter @jpfairless. In the meantime, be well.