The author has reviewed many overseas stock trading books, and 'stop loss' is often discussed in an extremely important position. Investors participate in market trading for the purpose of making money rather than losing money, as stop loss can lead to losses. Therefore, stop loss is often overlooked by many newcomers, but extensive research has proven that it is almost a necessary path to success.
A good trader should start by learning to stop losses.
Stay away from the demon of decline
For trading, a decline has a greater impact than an increase - this is a mathematical fact that many traders have to face.
When you lose 10%, you only need to rise 11% to return to your original position; When losing 20%, it needs to increase by 25%; When the loss is 33.33%, it needs to increase by 50%; And if you lose 50%, you need to increase it by 100% Because large losses can make trading extremely difficult in the future, skilled traders will try their best to avoid large losses. An important way to avoid large losses is to exit before making a mistake that has not escalated into a large loss, which is known as "stop loss".
Only by cutting losses as early as possible can we stay away from the terrifying "demon" of decline.
Of course, many novice traders are unwilling to cut their losses, and they even use Buffett as an example to find reasons for not cutting their losses. But the problem is that Buffett engages in value investing rather than trading, and the two are completely different. Buffett clearly knows the true value of his stocks, so for him, a decline is indeed a good opportunity to enter at a low price.
More importantly, Buffett's large cash reserves and continuous cash flow obtained through insurance company operations are the key to his ability to enter at a low price, which is obviously impossible for traders who are trying to gain a price difference by selling high and buying low.
In fact, even value investors are not uncommon to "take medicine" due to misreading valuations and failing to cut losses. The most famous one is naturally Bill Miller, who defeated S&P for more than a decade. He ultimately suffered a huge loss because he bought a large number of financial stocks more and more during the subprime crisis, and could only watch stocks that cost nearly 100 yuan eventually fall to only a few yuan.
Profit leverage with small stop loss
Investors who are proficient in using stop loss often regard a correct stop loss as a profit. They may feel that an investment would have lost 20%, but when it lost 5%, they stopped and left, which is equivalent to earning 15% of the price difference. This is undoubtedly a very beneficial psychological construction.
In fact, a good stop loss can not only be seen as a profit, but also as a profit leverage in itself. The position placement technique based on the percentage of total funds is a common method used by many experienced traders. Assuming they have a maximum loss limit of 2% per trade, if they have 100000 yuan in funds and a stock with a set stop loss level 5 yuan away from the market price, they can only buy a maximum of 400 shares. This way, once the stop loss occurs, they will lose exactly 2000 yuan.
Such a "safety valve" exists, and often we cannot trade at full capacity. For example, if the stock price is 100 yuan, buying 400 shares only requires 40000 yuan of funds, and the remaining 60000 yuan can only be idle. Otherwise, the risk of a single transaction will be greater than the prescribed 2% Assuming that this stock earns a 50% profit after purchase, the absolute profit is 20000 yuan, which is a 20% profit compared to the total 100000 yuan principal.
However, if we can set the stop loss for this stock to 4 yuan, then under the premise that the maximum loss of 100000 yuan cannot exceed 2%, we can buy 500 shares. The same stock price of 100 yuan can use 50000 yuan of funds, and a 50% increase can earn a profit of 25000 yuan, which is a 25% return compared to the principal.
Obviously, under the premise of position control, small stop loss can improve the utilization of funds, thereby significantly increasing the return on total funds while the trading variety also increases. This is especially true for investors who can use leverage to amplify trading.
If we set the stop loss to 1 yuan, the number of shares we can buy will increase to 2000, requiring a capital of 200000 yuan, which is twice the leverage. At this point, a 50% increase is equivalent to a profit of 100000 yuan, which is 100% profit compared to the principal of 100000 yuan. During this process, both the potential losses and the required increase remained unchanged.
Learn to find the 'optimal stop loss'
Of course, narrowing the stop loss space is not an easy task. If a large stop loss space is set, it is relatively difficult to be touched; If a small stop loss space is set, it may be shaken out of the market when there is a slight pullback. 'Small stop loss' is definitely a double-edged sword, which makes finding the best stop loss a technical task.
