To "make profits run" and "minimize losses", it is useful to learn how to use stop-loss!
The stop-loss is an automatic mechanism to order the sale of a security. For example, if you buy a stock worth 100 and don't want to run the risk of losing too much money if it crashes on the stock market, it is a good idea to set a limit price at which to sell to limit your losses. You can set this limit at 10% or 15%, so that if the share price falls to 90 or 85, the stock is automatically sold.
Steps
Step 1. As a method it should be remembered that the stop-loss has both positive and negative characteristics
First of all, it is difficult to apply for stocks that have high volatility. If the stock often moves 5% or more in a single week and the stop-loss is positioned too close to the current price, you could be forced to sell even if you didn't want to sell. In such circumstances a limit of around 20% or higher would be more appropriate. On the plus side, if you need to protect your capital at any cost, should the price move negatively, selling is an essential way to protect yourself. Of course, this ensures a 10% loss, but if the price drops, we will have saved a lot of money. Shares often rise and then fall in a fairly predictable manner - when the environment is favorable and a company is growing and making good profits, stock prices rise more and more. If, on the other hand, the situation is grim and losses are being borne, the decline in the price could last for months or years and the value of the company could be wiped out.
Step 2. To take advantage of any trend you use the 'trailing stop-loss' or mobile stop-loss
It is a more active approach to stock prices and performance and is designed to 'run profits and minimize losses'.
Step 3. To put into practice a trailing stop-loss you set a number of points or a percentage relative to the current price of the stock
This sets the minimum - the automatic signal to sell if the price breaks through on the way down. But if the price were to go up, the stop-loss would automatically move up by the same percentage that the stock's price went up. In this way the sell signal will always remain (for example) below 15% of the current price, but it will always be higher than the previous signal. Whenever the stock price rises, the sell signal is shifted. This mechanism has the effect of blocking and securing ever-increasing profits. If the price were to reverse the trend, the stock would be sold at the last highest level of the stop, but if the stock were to continue to rise, profits would also be gained from these further increases.
Advice
- If you want to check how this mechanism works, choose a stock, take the price chart and follow the price trend for a few days. For example, set a stop-loss of 10% below the current price and follow the trend of the chart for a few weeks. Each time the stock hits a new high, it moves the stop-loss up. If the price remains unchanged or falls, follow the chart without moving the stop-loss. In a short time everything will be very clear and particularly simple to implement.
- Other examples: in recent years (since 2008) the perfect stop-loss for USO stock (an oil ETF) has been -20%. For the MT stock (Maire Tecnimont) a -30%. Something similar for SMS too. These cyclical stocks are some of the most volatile, so you never run the risk of losing more than 30% for any type of stock! These stop levels would have supported the fluctuations in prices that have occurred in recent years, but would have led to the sale of the securities before the market crash that occurred in October 2008.
- The success of this type of strategy depends on optimizing the level at which the stop is set. For a certain period of time there is a trailing stop value at which the stock will be sold at the highest possible value. If the stop is set too tight, the stock will sell out too soon before it peaks. If the stop is set too large, the stock will be sold too far below the peak after the peak has occurred.
- For the DJIA index (Dow Jones Industrial Average) the best stop was around -15%. This was the drop recorded from the highs that occurred between October 2007 and January 2008. (That drop exceeded the declines recorded in the previous 5 years when the market was bullish or as industry experts say in the US it was "bull" and should have been interpreted as a generalized sell signal.)
Warnings
- The more the securities dossier is moved, the more commissions to be paid are accumulated.
- The opportunities for stocks that are moving upwards should not be missed.
- The trailing stop level below the current stock price must be set very carefully. It is expressed as a percentage of the current price. O'Neil of Investor Business Daily, based on his own analysis of stock price history, recommends an 8% level. However, for particularly volatile stocks, this stop level would result in frequent selling. This would involve:
- Prices are based on maximum bid, and since bids occur before the market opens, you may end up seeing yourself selling the stock at a time when you didn't expect it. To avoid this you should set the stop percentage at a higher level than the expected loss.
- Trailing stops cannot replace a careful and constant analysis of the stock, but they allow us to avoid some of the "emotional" and impulsive sales since they exclude us from the process.
- Trailing stops offer some type of automatic capital protection. However, there are always risks in implementing this system.
