Lesson 7 – Risk management rules

/Lesson 7 – Risk management rules

Tip 1 – Always use a stop loss.

A stop loss is exactly as the name suggests, an instruction to a broker to sell a particular stock if the price falls to a certain level, hence “stopping the loss”. If you can successfully do this your capital will remain largely intact ready for the next trade.

A “stop loss” order is an instruction given to your broker (or placed on your trading platform) that is an instruction to “sell xyz at market when the price trades at you nominated level”. 

For instance you own a stock and decide that if the price starts to decline and trades at say $1.65 then you will exit the trade. You then place a “stop loss” at $1.65. Generally the trade will be executed at $1.65 however there are exceptions. On occasions there may not be enough buyers at $1.65 to absorb your sell order so your order may be executed at a lower price.

There is also the potential for a large fall at the opening price due to negative overnight news. In this case prices may “gap down” and your order may be executed at a level far below your stop loss price.

Consider a time based stop loss

At varying stages during your trading career you will find that you have invested in a stock and the price stagnates, sometimes for several months. Rather than sit around with your capital tied up, wondering what you do, you might have a rule that states:

 

Never lower a stop loss

This appears to be a simple rule and easy to obey, however once you start trading and the price of a stock approaches your stop loss the temptation is to lower your stop a few cents. If you have done your homework correctly in the first instance there is no point lowering the stop, that action will only cost you more money.