Thursday, September 17, 2009

Survival Kit For Newbie Investor - Stop Loss Order

In the last post we had realised that making few right decisions can completely protect our Capital and thus allow us to be triumphant in stock market ever after (http://archana-archdeb.blogspot.com/2009/09/starter-kit-for-newbie-investor-capital.html). Even Warren Buffet maintains that to be successful "you only have to do a very few things right in life so long as you don't do too many things wrong". But there is a catch here. You are bound to take many wrong decisions in stock market over the long haul. Warren Buffet was well equipped to avoid too many wrong decisions, besides being properly groomed in trading right from early childhood. A little known fact is that Warren Buffet's father was a stock-broker and a parent's influence at an early age in such matters can have tremendous advantage. But most of us are not so very well placed and hence will be prone to making many mistakes while taking trading decisions.

If that be so then what is the solution? The solution lies in limiting your losses from wrong decisions by way of Stop Loss Order. We shall now postulate some golden rules in the words of a legendary trader W D Gann:-
  • Rule #1. Remember when you make a trade, you can be wrong, therefore place a stop loss order for your protection.

  • Rule #2. When in doubt, get out of the market.

  • Rule #3. When you have nothing but hope to hold on to, get out of the market.

With due deference to W D Gann's rules, I would like to hazard a couple of exceptions to the general rule of applying Stop Loss Order in all trades. If you are an investor never put a stop loss order when the stock is trading 80% below its all time high. If you feel that you are entering into a good trade at that level, just go right ahead and buy without stop loss order. You will get a chance to exit honourably even if your trade goes wrong. Simply hold the scrip with patience.

Secondly, if you have confirmation that you are buying in the 2nd phase of a bull run then you may dispense off with stop loss order because the stock price is bound to move above the previous high. If you are not placing stop loss order, then you need to have a firm mind and not panic under any circumstances. In next post we shall dwell upon certain issues relating to investor psychology.