You have to consider each situation and your method of trading to see whether you should put your stop loss order in the market. Whether or not you do, you should always know the price point at which you can safely assume that the trade has failed, and should cut your losses. One of the difficult ideas for novices is that this can be thought of as a successful trade.
Think about it, no trading plan or system is going to produce 100% wins, in fact if your system makes as much as 70% good calls it is doing better than many profitable systems. You can even lose as often or more often than you win and still have a good profit, because it all comes down to money management. Van Tharp spoke in his book ‘Trade Your Way to Financial Freedom’ of a random stock selection system that still produced a modest profit because good money management was in place.
So one of the fundamental concepts that you must realize is that a losing trade exited in a timely manner is still a success, provided it was executed in accordance with your trading plan and not on a whim.
Stop losses are an essential tool for any successful CFD trader. Due to the high margins that CFDs are traded on, small losses can quickly become big ones. All good traders are going to experience losses, it’s knowing how to minimize these losses and maximize gains that translates to a successful trading strategy.
To Set or Not to Set
The required stop loss position is therefore clear at the start of the trade, and the only question is whether you reveal it to your broker and the market by placing the order. One of the factors to consider is if your broker is a market maker in your selected market, or whether the financial instruments are being traded on an exchange. With the Forex market, there can be a difficulty with some brokers, so even though the market, at more than $4 trillion traded per day, is large enough that it’s very difficult for traders to manipulate, you can still be exposed to the broker’s dealings.
That’s not to say that the overall Forex market can’t be manipulated by traders, but it’s infrequent. It’s most likely to happen at periods of low activity, when the major trading markets are asleep, and it requires a major financial institution to have the capital to do it. It’s not illegal, but it can be detrimental to you so is something to be aware of.
However, when considering trading in equities, the amount of cash flow is much smaller. If the shares you are interested in have a relatively small volume of trading, this is subject to manipulation with a big investor intentionally moving the prices by their actions. Some traders purposely choose to ignore the smaller stocks, both for this reason and because more heavily traded shares are more likely to behave rationally and predictably.
You may be alright placing your stop loss orders on the market if you make sure that you trade in periods of higher activity, and on more popular securities. You may not have a choice, if you are unable to keep a watch on the market movements frequently enough. If you are swing trading your plan might be to only look at the closing prices each day, and ignore intraday fluctuations, and in this case you would want to avoid putting orders on the market. Stop loss hunting is a real issue that can affect your trading, and you need to be mindful of it to avoid trouble.
Inspiration: David Smith’s Trading Story
Many people dream about ways to supplement their income so they can reduce their mortgage and relieve some of their mounting financial pressures. One Brisbane engineer has gone a step further and found a way to do just that. At 35, David Smith has spent the past few years learning to successfully trade the Australian stock market and the results have been worth all the hard work.
In the first quarter of 2008 when the Australian stock market plummetted and lost over 20% of its value, David Smith saw his trading float increase 174.93%*. At the beginning of 2008 his trading float was $6,000 and by the end of March his float was $16,495.52.
“I feel very encouraged that if my system is working and I manage my risk I can make money. My float is small and therefore I am reinvesting most of my profits back into my float,” said David.
David trades Contracts for Difference (CFDs) which enables him to make his small float work harder for him. He trades multiple systems to ensure he is prepared for varying market behaviour. Given that David works full time he has designed a number of his systems so that he only needs to manage them weekly. This means that on the weekend when he has more time he can adjust his trend following systems as required. In addition, David uses a trading strategy called ‘dip buy’ or ‘mean reversion’ which requires him to check the system every night when he comes home from work. This strategy is applied to both the long and short side of the market. On average, David manages about 10 to 20 open positions per week.
David’s trading results have not always been so good. He initially started trading the stock market using fundamental principles. He subscribed to newsletters about which shares to buy and sell, plus he read the business news. Unfortunately, this resulted in some losses.
“I also initially lost money on CFDs and then realised that I needed some education if I was going to continue. I was nervous about spending money on education after losing a fair bit trading.”
“I spent most of 2007 learning how to develop my own technical trading systems and most importantly how to manage my risk so I wouldn’t watch my money disappear again. I would have spent hundreds of hours in front of the computer designing my systems.”
“One of the biggest lessons I have learnt while learning and through trading experiences was that I needed to reduce my risk significantly to protect my capital. I didn’t like seeing my trading account fluctuate so much,” said David.
David puts part of his success down to being fairly scientifically minded and therefore he finds it relatively easy to stick to his system. He also attends regular meetings in Brisbane with other traders to problem solve and discuss trading strategies. “My biggest losses were made when I deviated from my system.”
“For anyone starting out in the stock market I would suggest they don’t use too much money in the beginning and they allow enough time to recognise how you cope with intra-trade drawdown,” said David.
In the long term, David would like to use his trading profits to reduce the mortgage and finish the garden of their newly built home, for his wife and 2-year old daughter.
Remember that CFDs are geared and can result in losses that exceed your initial deposit. They may not be suitable for everyone, so please make sure that you fully understand the risks involved.