All of a sudden, your favorite stock is falling out of the sky.
What do you do? Sell? Hold?
Unfortunately, many traders aren’t really sure, so they make impulsive decisions. Instead of calmly looking into why a stock may be falling (sometimes for no reason), they may panic and sell on emotion.
However, it’s possible to remove that emotion by using a trailing stop loss. Such a stop keeps us from selling our stocks at the wrong time, while preventing losses from wiping out your portfolio. Basically, it forces a stock to be sold and removes emotions from the equation.
Let’s use Apple (AAPL) stock, as an example.
Let’s also say you bought shares at $147 a share, with a trailing stop loss of $10. Now, if the price of Apple moves to $157, the trailing stop would reset at $147, or $157-$10. However, if the price of the stock now falls, the stop loss price doesn’t change. It would stay at $147.
Once that stop is hit, you’re out automatically. There’s no second-guessing. If your stock pushes higher, the trailing stop resets higher, too, never triggering until the stock drops.
Traders Can Also Rely on Hard Stop Losses
Traders can also use a hard stop loss order.
With this order, the price won’t readjust as a trailing stop would. Instead, once your stock pulls back to your set stop loss, the trade is over. Think of it as an insurance policy that’ll protect you if the stock falls. Some traders use a -25% stop loss, for example. If the stock falls 25% from your buy-in price, the stop is triggered and the trade is over.
In a market as volatile as ours, stop losses and trailing stop losses are essential. Both keep you in winners and get you out of losers, while removing emotion. And, both serve as a strong insurance policy. The last thing you want to see is a significant loss from a trade you should have closed weeks prior.
I’ll leave you with this example of why stop losses are crucial.
An old friend of mine once risked $45,000 on what he thought was a “sure thing.” He refused to set a stop because he was so sure the stock would skyrocket. Two days later, he closed that “sure thing” for a loss of $38,000.
Needless to say, his wife was peeved.