Friday, January 13, 2012

Limiting losses, via the stop loss

Trading in stock markets can be as tricky as a monkey. One may use all his skill and will but may still avoid making profits if stop loss is ignored. The first step while creating a position should be to determine these two crucial levels. Failing this the investor might lose his capital over a period of time as it becomes difficult to book profit orlosses without a stop loss level.

Various strategies may be used for setting the stop loss. The trader may fix a stop loss which remains same irrespective of the stock price. Instead a strategy of trailing stop loss can also be employed whereby the trader revises his stop loss as and when the stock moves in profit giving range.

Not only setting a stop loss and target price is important but setting them at proper levels is even more crucial. The level at which the stop loss is set depends upon the volatility of the security. For securities which are volatile one may give the position a more space to move as against a stable security. One may also use a strategy whereby stop loss is fixed in such a way that the loss suffered at stop loss price is a certain percentage of the returns expected at the target price. This percentage may vary according to traders of different types i.e. high for a risk taker and less for a risk averse person. But as a thumb rule this percentage can be 25%. Such a strategy will ensure that the trader earns sufficient returns even if he predicts the price movements with just 50% accuracy.

Stop loss is a simple tool but can be highly effective to keep emotions in check while trading. However setting a stop loss is an art and it requires time to master what strategy should be applied when.

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