Stock Day Trading System - The Stop
You've been trying to come up with a stock day trading system that works. You've been looking at hundreds, maybe thousands of stock charts, wondering "How can I make some money from this game?".
CUT YOUR LOSSES SHORT and LET YOUR WINNERS RUN
If you've spent any amount of time reading about intraday stock trading or trying to come up with a stock day trading system, then you must of stumbled upon the old saying "cut your losses short and let your winners run". Have you heard that one?
This is one day trading rule you can definitely put your money on. In fact, it is so important, that whenever I tried to come up with a new stock day trading system or method, that was the first concept that came to mind.
Fortunately, when I began my trading education, I started out reading Investor's Business Daily (IBD). IBD put me on the right path to cutting losses short and letting winners run, while learning how to swing and position trade in my early trading years (1990's). IBD recommended cutting losses at around 5% - 8% below the entry price of the stock on a breakout.
I later took this "cut your losses short" idea further and really tightened my stops, by placing stops much closer to the breakouts, utilizing natural support lines or areas, therefore minimizing my risk. Yes, I experienced less winning trades, but I really enjoyed knowing, that if I was going to get stopped out, I was risking very small amounts of money, unless of course the stock dropped like a rock over night. There's not a whole lot you can do about that when swing or position trading. That is one major advantage that day stock trading has over swing or position trading.
You'll find that some traders talk about not using stops period. I know I'll catch flak here in my email or blog by saying this, but in my opinion, unlessyou're trading a reversal system that puts you back into a trade in the opposite direction, I think it's crazy to design a stock day trading system without a stop. The stop is your money's first line of defense!! If you're a newbie, please take this day trading advice now. Always, always, know where your stop is going to be placed before you enter the trade.
WHAT DOES A STOP DO?
We all love winning trades. They make you feel good. They tell you that what you're doing is right and to keep on doing it.........the problem is most of you will will be using a stock day trading system or method, that has more losing trades than winning trades. But that's OK! Later, I'll go over why it's OK when I discuss Expectancy. Right now, I want you to understand the purpose of a stop and why it's so important, because you are going to be stopped out of ALOT of trades. Relax, it will be perfectly normal to have many losing trades.
Let me be blunt and tell you what's going to happen if you don't use a day trading system with stops. First, you're going to call your broker and ask him to send you a check for the few remaining dollars in your account. Next, you will go back to your desk and try to come up with a trading method, this time using stops. Just be smart and learn to day trade right and get it right the first time.
So what does the stop do? This isn't rocket science. Since I have said, you're going to have lots and lots of losing trades in normal trading to make money. Your stock day trading system must have a way of limiting the risk on those losing trades. You will say to yourself "This is the maximum amount of loss that I will take on this trade. No more." You might decide that amount based on support and resistance, volatility, percentage movement, etc. Whatever method you decide to use, the STOP is your line in the sand. Here's another day trading tip: If you get into the habit of moving your stops further away from the price as it gets close to stopping you out, you're screwed. That's right, screwed! It might help you on a few trades, but in the long run you're screwed. Don't do it.
WHY ARE STOPS IMPORTANT?
In the next section on EXITS, I will be discussing the latter part of the old saying "cut your losses short and let your winners run", but it's important for you understand now, that to make it easier to "let your winners run", in the course of a day trading session, you must concentrate on finding trades that allow a relatively small amount of risk. Unless you plan to do counter-trend type trading, any stock day trading system that you use must have the goal of producing profits that are at least some multiple (e.g. 2x, 3x, 4x, etc.) of the amount of your stop. Why do the profits have to be so much larger than the stops? Because like I said earlier, You are going to have lots and lots of losing trades, Most likely, more than 50% of your trades will be losers..
Don't get all depressed, because I said more than half of your trades will be losers. This is all part of trading. You make up for all those losers, by having winners that are larger, sometimes much larger than the average losing trade. So, if you need to have winners that are larger, by say triple your stop, doesn't it make sense that it will be easier to achieve this goal by using small stops? The larger the stop, the further price has to go to reach any certain multiple of it. The further the distance price has to go, the smaller the probability price has of getting there.
Take a look at the next two charts and you'll see what I mean.
This first chart is an example of a typical breakout trade that you might make. Note how small the chart pattern is and how tightly the risk is controlled with a very small stop.
OK, now this is the same chart as above, zoomed in. I want you to see how easy it is for a stock, when stops are small, to give profits that are over 3 times larger than the amount you risked on the trade.
Here is an example of what can happen if you place stops to far away from the entry. Notice that although it would've been a winning trade, the profit level never even came close to a 2 x STOP level.
Yes, having wider stops means having a higher percentage of winning trades, but it also means your average losing trade will be higher. With day stock trading, since your time in the trade is very limited, you must concentrate on finding trading opportunities that not only show promise for stock price expansion, but also offer areas of tight stop management. If you want to learn day trading properly, understand that stops are an extremely important part of your stock day trading system. More important than any setup or entry method.
No matter what method of day trading stop loss you choose, it must allow you to build profits on the winning trades that are as large a multiple of the stop loss as possible. We'll go over letting your profits/winners run in the next section called THE EXIT, but make sure you you grasp the idea that when day trading stocks, small stops is the way to go. You can certainly use relatively large stops when swing or position trading, because you've got plenty of time, days, weeks or months to realize much larger price movements. Maybe even winners that are 10x or 20x your stop loss. With day trading there's only hours to grab those profits. So keep those stops as small as possible.
Learn day trading the right way from the start. Whatever stock day trading system you decide to use, at least make sure that you know exactly where you are getting out ahead of the entry.
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