Risk is the other name for stock markets. The moment you enter the markets, the risk of losses to your capital or invested money starts. But the associated risk doesn’t make trading or investing in markets unpopular.
To survive in field of stock trading or stock investing, it is important to save your capital or invested money from the avoidable losses. You can do this if you cut losses to the minimum.
The fact is that the equities or stock markets are considered the best asset class among the investors. It is the equities which are capable of delivering best returns to the investors in the long run while beating the inflation rates.
Same is true for short term trading where you can get very decent profits on your trades in a short time. The need is to be able to manage your trades and cut losses on your trades.
Tips To Cut Losses in Stock Trading
Always keep in mind that all these profits come while taking a substantial risk in trading. If you can contain your risk, trading can be a fortune turner for you.
While you can never reduce risk to Zero, you can always reduce this risk of loss significantly by following some simple market rules.
Cutting the losses is as important as earning the profits. It becomes extremely important, especially, in intraday trading where there is no luxury of time. In the end, cutting losses is important part of your trading strategy irrespective of your time horizon for the trades.
Using Support and Resistance Lines
Support and Resistance lines make an important and essential part of your trading plan. Before going for a trade, you should be prepared with the support and resistance price levels for the stock or security you are going to trade in.
Support is the price level below which a stock is less likely to fall while a resistance is a price level above which the stock is less likely to move.
While a stock can always move above or below these levels, they provide you the range in which you have to play the stock.
If you want go long or buy the stock, you should be buying it as near as possible to the support level but not if this level is breached. Similarly, if you want to short or sell the stock, do it as near as possible to the resistance level.
These levels act as your stop losses and in case the stock breaches these price levels, the loss incurred to you is relatively smaller.
Using Stop Loss – What is Stop Loss
Before you start trading stocks, it is very important to know if what is stop loss and what is stop loss order.
Stop loss is a word made up of ‘stop’ and ‘loss’. That means stopping losses in a trade. So stop loss is a stock price level at which you exit a loosing trade and stop your losses mounting.
Stop loss price is determined on the basis of technical analysis. We use support and resistance lines to find out our stop losses for a trade. For intraday trading, we can use pivot points also to find stop loss and target prices.
Let’s take an example to understand the stop loss. Suppose a stock xyz is trading at a price level of 500. It has support line corresponding to 490. You expect the stock to move towards 520 or 530.
Now you can take a trade at current price of 500. You will keep your stop loss at 490. If the stock doesn’t move up and starts falling, your stop loss order at 490 will be executed when stock price falls to 490. You will come out of the trade.
If you hadn’t placed a stop loss at 490 and stock falls more downwards, your losses will increase. By placing a a stop loss, you have stopped your losses.
You should make it your habit to use stop loss in your trade. Sometimes we think that we will keep stop loss in our mind and actually don’t apply it in fear of getting it triggered. This is because we don’t want to exit our trading position taking it to our ego that we can not go wrong.
It is always in your favour to apply stop loss in your trade and get out of the trade gracefully if it gets triggered. Remember, market is always right. Secondly, never re-enter that trade even if stock again moves above your stop loss after breaching it.
You can also use stop loss to enter a trade also like we talked above for exiting the trade. This is done when you have the urgency to enter a trade but the stock is trading away from the support or resistance level.
Suppose a stock is trading at ₹ 500 and support is at 480. You want to enter near 480 but are afraid that stock may not test 480 and may move higher but you also want to wait for 480. You can keep stop loss buy order little higher above 500 and wait for correction in stock.
If the stock corrects or falls, you can trail stop loss lower and if stock doesn’t correct but moves higher, your stop loss will get triggered and you enter the trade.
The disadvantage with this is that method is that you end up entering the trade at little higher price. Similarly, you can use stop loss sell orders for shorting or short selling the stocks.
In case of short selling, you have already sold the stocks and you have to buy the stocks to close your position. In short selling, if the stock falls below your selling price, then you make profits. If it starts moving higher, then it is a loosing trade and you need to stop your losses.
Analysing Risk to Reward Ratio
After you find your support and resistance levels for the trade, next you should analyse the Risk to Reward Ratio. Are you going to get enough return on the trade for the risk taken?
You should look to trade the trades only with risk to reward ratio equal to greater than 1:3. While most of the trades don’t fit into risk to reward ratio parameter, you will be thus avoiding unnecessary trades. This saves you of undue brokerages and losses on these trades.
Risk Management And Position Sizing
This is most important thing to do in stock trading. Trading not only includes reading charts but also mathematical applications to be profitable over the time period.
Appropriate position sizing ensures that your losses are small in case of loosing trades. You should apply 1% rule of risk management while trading.
1% rule states that in any trade, you do not risk more than 1% of your total trading capital. Fixing risk to 1% ensures that you do not take large trading positions, thus exposing yourself to big losses.
Preferring Limit Orders
While placing orders for a trade, you can do it in two ways : Market order and Limit order. It is important that you prefer Limit Orders to Market Orders as far as possible.
A Limit Order is an order which you want to be executed at predetermined price by you. It is your preferred buying or selling order.
Stock prices are not static. The keep on changing every second. When you place your order as market order, the order is executed at current price. So it can be different than what you saw when checking. This is because the price changes in the time period between checking and placing your order.
A limit order is executed when the stock price comes at limit price. It may take time to get executed because you can only wait for the stock price to reach at that price. It may never be executed if stock price doesn’t reach there.
While the advantage with Limit Order is that you are entering the trade at your chosen price, the disadvantage is that it may not get executed if the stock price doesn’t visit that price. The market order insures your entry into the trade, this price may be different than the price you wanted to enter in.
This is not a technical point to cut losses. But it has its own importance. You may have seen by yourself that whenever you buy or sell a stock, the stock starts moving in your undesired direction. You are left regretting that had I waited little more I would have bought it lower.
Patience coincides with our first rule of waiting till support and resistance. Stocks have highly likelihood of testing these level. All it requires is little Patience from you. Patience ensures you enter the trade at a better price.
Following these simple rules ensures that your trading losses are cut significantly.If you have any more in your mind or you learnt with your experience in markets,share with us!