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Saturday, September 02, 2006

Stop Loss

Every once in a while i get an email from new traders asking me to analyze a trade they sent to me - show them what they did wrong, if the indicators are using are the right ones, what I would have done in that situation. For the most part, new traders are heading in the right direction as far as analyzing the market and establishing a directional bias, but the thing that gets me is when I ask about stops and profit targets, all i get in response is "huh?" or "never thought about that." This blows my mind.

Being a trader is not just about looking at a market and picking a direction. That's a small part of it. The biggest part is what you do after you have entered your orders. After that order is in and filled you become a position manager. What happens if the trade goes your way? What happens if it doesn't? These are questions that should be asked before you enter your orders. You have to asses your potential risk and reward - know when to let the profits run and when to cut your losses and get out of a trade.

I've been reading "Inside the House of Money" by Steven Drobny. It's a great book that I highly recommend, especially if you long to become a money manager or a global trader/investor. In the book he interviews Dr. John Porter who is the biggest money slinger over at Barclays Capital, one of the UK's largest financial institutions. After recalling one of his worst trading mistakes, Dr. Porter makes a great statement on stop losses: "I learned that the stop-loss is by far the most important aspect to a trade. Going back to discipline, the stop-loss is a very difficult thing to implement, but if you have a proper stop-loss, you'll never blow up. You'll be out long before you get anywhere near the end." This is a great statement in that it's coming from one of the biggest traders on earth, and if he thinks stop losses are important, shouldn't you?

So, the moral of the story is kiddos to plan your trade and trade your plan - with some stop losses - and you'll live to trade another day. =)

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