Before you are able to determine if a stop loss is truly necessary, you need to know what a stop loss is.
There are a handful of stop loss types which we will leave to another day. All stop loss types serve one purpose – to close the trade (sell if you bought the stock, and buy if you sold the stock short) at a predetermined level.
Example 1: AEM (AWX:SI)
AEM is on a strong bull run. If you were to buy AEM at that pink arrow for $1.72, your stop loss will be in the red rectangular area; which is about $1.60. AEM will be sold at $1.60 if it drops to that price level.
Please note that I strongly recommend you to trade with the trend.
Example 2: SembCorp Industries (U96:SI)
SembCorp Industries has been on the slide. If you were to sell it short at the pink arrow for $3.01,your stop loss will be in the red rectangular area; which is about $3.10. SembCorp Industries will be bought back to close your trade when it rallies to $3.10.
Again, please note that trading with the trend is highly recommended. With the basic understanding of how stop loss works, we are ready to tackle the pros and cons.
A stop loss is NOT necessary if
#1 You can afford to lose the money risked
If your position size is small, the amount you have risked is even smaller. The stock should ideally be lowly priced (dollar absolute amount rather than value), in addition.
#2 You are mentally and emotionally strong (aka emotionless)
With fear, greed and irrationality out of the window, you do not need a stop loss.
#3 You have the time and ability to sit through the entire trading session
Without a stop loss, you will need to monitor your stocks really closely. This hardly leaves you any time to rest and go for breaks.
This is possible if you are day trading or scalping. All you need to do is to stay at your screen – from waiting for the opportunity to present itself to the point of exiting the trade. This could be as short as a couple of seconds to as long as a couple of hours.
A stop loss is necessary if
#1 You are looking to preserve your capital
This is in the context where we trade more expensive stocks (dollar absolute amount) and that we have limited funds. Each of our position should be at least 30 units to make the trade worthwhile (not forgetting that we incur commission fees for each transaction).
Find out which broker suits you best.
#2 You want to live to trade another day.
You are not going to monitor the stock every single second (ok, maybe minute). Therefore, if you intend to trade the US market (day trading excluded) and sleep before the market closes, you need a stop loss. Your stop loss will help you get out of your position even when your computer is turned off.
#3 Your intended trading time frame is beyond a couple of hours
You are able to take time off to complete other tasks or rest in full peace that you won’t lose more than what you have set (unless there’s a catastrophic event which is for another day).
Since employing a stop loss is free and gives you a peace of mind, why not use it? Go watch that video, enjoy your hobby or even exercise while you let your trade play out.
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