You read the title and you probably think that I have lost my mind to say that getting stopped out of a trade is a good thing – especially when the objective of trading is to make money…and not lose money!
No, I get it! Nobody likes being stopped out of a trade and I surely am one as well, who despises it. But I have gotten used to it. In fact, taking a loss on a trade is pretty much as easy as breathing.
That is contrary to what most think when it comes to trading, as most traders abhor the thought of closing out a trade for a loss.
You just can’t allow yourself to get hung up on a trade that goes against you. Even as I write this article, I cut a losing trade from my portfolio this morning that wasn’t working the way I expected. The loss stayed small and is easy to recover from. My remaining positions were all profitable and pushing some solid gains that more than erased the losses from the aforementioned trade. But lets get a little more indepth about the ‘goodness’ that comes from being stopped out.
I have 5 reasons why it is good to be stopped out of a trade and how it actually improves your trading.
In fact, when you manage your losing trades correctly, it is AMAZING what it does for your account.
Reason #1: Keeps you from getting stuck in a long-term losing position
I have a friend (don’t act so shocked!), that proudly proclaims the fact that he has never has never closed out a losing trade in his life….and he is right. But his portfolio is littered with trades that will never become winners (*Cough-Cough* GPRO *Cough-Cough*), while only closing out his winning positions. Essentially, he lets his losers run, and cuts his winners short.
That is honestly the opposite of everything you do to be successful in the stock market. I can’t tell you how many people that I have met that enter into a trade, with no stop-loss in mind, and proceed to watch the trade move against them, but with no exit strategy whatsoever to fall back on.
What ends up happening is that trader finds themselves turning a short-term trade into a long-term investment.
If you are wondering if you are one of those people, ask yourself, of the positions in your portfolio, have you ever said the following:
- “I think I am just going to hold it for the long-term.”
- “There is no way I can sell for that big of a loss”
- “I’m okay with holding this stock long-term – it has solid fundamentals”
- “If it gets back to break even, I’ll sell”
- “I just need to make my money back”
The problem with all of these statements is that it is all about “I”, “I”, “I”!
No consideration at all for what the market is doing, just what the trader NEEDS the stock to do.
Let me tell you, there isn’t a stock or a market out there that cares a flying-flip about your needs or wants. It could careless where your entry price is, or what your target price is set at.
The only thing that the stock market respects are stop-losses.
It is the only way to keep losses manageable and in many ways irrelevant.
Reason #2: Your emotions stay level
Again, there is nothing fun about a losing trade. I hate them as much as anybody, but when you use stop-losses, and keep those stops tight as possible, your emotions will remain much more under control. They won’t get away from you.
When you have 15% or 20% losses that is where your emotions start to run high and are susceptible to even bigger losses. That is what you have to protect yourself from. When that happens, you start to make bad trades in response, and even worse, start to revenge trade against the market!
When you keep to the stop-loss that you decide on BEFORE you ever get in the trade, you make the decision to get out automatically and without emotions playing a key role in the decision making process. Sure, it isn’t a thrilling experience to be stopped out, but you knew going into the trade you’d get out at your predetermined price if the trade did not turn a profit.
What is also important, is that you don’t find yourself agonizing over whether to stay in the trade or whether to get out of the trade.
Your stop-loss determined that for you.
So use stop-losses, they’ll keep your emotions from overtaking your better judgement, make losing trades manageable and set you up for long-term success.
RELATED: How to Use Stop Loss Orders + Increase Trading Profits
Reason #3: Gives you the ability to stay flexible to changes in market direction
The stock market won’t always go up and it won’t always continue to sell-off. In uptrends there will be pullbacks, and in sell-offs there will be bounces (i.e. dead cat bounces). That is part of the normal process of trading.
But when you don’t cut losers, when you don’t use stop-losses, and even worse, when you ignore the stop-loss that you set out to follow, you reduce your ability, if not completely eliminate your ability, to be flexible with the ebbs and flows of the stock market.
I keep my stop-losses tight.
When I am wrong on a trade, I like to know very quickly that I am wrong so that I am not stuck in very obvious and bad trades, waiting for the stock to simply stop out further down the road.
When I know the trade has gone wrong, I want to immediately be out of the trade and not a moment later!
In doing so, my bias can flow with the direction of the market because often times my stops are triggered because the market is trading in a different direction than where my positions are taking me.
More times than not, whether a trade is stopped out, is often the result of the direction the market is trading in relation to your position that you hold.
That way, when the market tanks and decides to reverse a long-standing uptrend, you aren’t holding your positions throughout the duration of the sell-off. You get out early, and maintain the flexibility to get short with the market without having a bias that is based on your need to have a horribly unprofitable position turn profitable again somehow.
Being flexible with the market and not holding onto inner biases as it pertains to the stock market’s direction is such an important aspect of consistently profiting. By following what the market thinks rather than what you think it should be doing will make a huge different in your portfolio’s profitability.
Reason #4: Stop-losses will free up capital to pursue a better trade
I’ve never understood why someone stays in a losing trade.
The same trade that is losing you money, you are counting on to make that money back for you.
If you’ve lost $1,000 on a trade, you obviously want to make that $1,000 back. Does it really matter if you make it back on the stock that you are continuously losing money on, or does it make better sense to learn your lesson from that trade, and put that money towards a stock that has a better chance at making you a profit?
Put your money on trades that give you the best chance to win.
Losing trades don’t give you that.
Find a good, solid trade setup and trade it, but make sure to use a stop-loss. You have a much better chance at getting a better return on it, than one that you refused to take a loss early on with.
When it comes to stop-losses, they don’t allow you to stay in a losing trade for a long period of time. Instead, it frees up capital, takes away the bad trades and allows you to pursue a better trade, and a better return on your money.
Stop-Losses Work and That is a Good Thing
Most people won’t use them, because they can’t stand to lose money in the stock market.
But don’t let that be your fate!
Closing out losing trades early and often is one of the best things you can do for your portfolio in order to keep the losses small, while maximizing the value that comes from your winning trades. The best, and in my opinion, the only way to do this, is by using hard and firm stop-losses that you determine before you ever even place the trade.
This is called discipline.
This is what it takes to consistently profit.
And you can’t do either if you aren’t willing to allow your trades to get stopped out.
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