A stop-loss is a commonly placed market order that's entered to help protect investors by triggering a sale on a stocks position once it reaches a certain price. Today we are going to let you in on a little trading secret. We are going against the grain here and try to explain to you why stop losses are the single biggest factor why most novice and inexperienced traders lose money in the stock market. The reason behind why most stock losses probably occur, is before a stock trends higher, it typically takes a dip and trends lower and nervous people sell. It is important for you to grasp that market makers, specialists, and experienced traders are out to make money for themselves or their firms. They are out searching to make money from your inexperience and they all have access to resources, tools and information that you don't.
Now listen, these sharks see your open positions sitting out there and they know that you are willing to sell to them at your stop price (the order is in) and they are searching for these easy pickings, to stop you out and make money from your mistakes. More often than not if they are planning on taking a security higher - they will drop the bid first scooping up your stock taking you out at that stop price. They want to buy it cheap and they know where to get it. Then they will proceed to move the stock much higher and are happy to own your shares that you were offering up for sale. And guess what? Now your out of that trade, with a realized loss!
So, the lesson here is, If your frightened about a trade or scared to lose your money or just uncomfortable with that trade then "sit it out" don't do it. We see this scenario take place time and time again. So, it is better that if you feel the need to have a stop-loss in place, put a looser stop-loss of maybe 30% to 35%, as to not make it too tight so your easily stopped out. There are people out there who are looking for people with tight stop losses. These professionals know the stock market very well and are scouring it looking for tight stops and looking to capitalize off of it. We tell our subscribers to generally try and keep stop losses on the looser side when possible.
Using a stop loss is like going into a casino sitting at the poker table and showing everyone at that table your cards, including the dealer. So don't use a tight stop loss. It is the easiest way to ensure that a wall street professional trader will pick your pocket. We see this scenario time and time again. It is paramount that you understand that a majority of your losses are coming from stop losses that you have in place right before the stocks begins to go higher and you are the loser. I'm sure this has never happened to you?
In our opinion the best stop loss that you can make for yourself are mental stop losses. But you must be diligent and stick to your trading parameters. We will go on the record here and tell you that tight stop losses are the single biggest mistake novice traders make when they start trading stocks.
I will stress it again, market makers have a lot more data and tools at their disposal than retail traders do. They are able see your order entries and they have the power to move the markets against you. Not to mention stop losses can’t guarantee you complete protection against even market losses. But they do increase the odds you will miss out on the upside all together, plus they increase trade costs. Also, there is no evidence to support claims that they produce better results, but there’s plenty of evidence to the contrary. It is better to start to think of stop losses by their contrarian name that describes them better " stop-gains."
In addition, because stock prices tend to fall so rapidly, most stop losses entered can't be filled quickly enough and many investor's stocks are sold out at prices well below their triggered stop price. We see it often enough, that most stocks will then rebounded quickly, making the situation even more painful for the traders who are stopped out at the bottom.
Another major worry in regards to stop loss orders is once your stop order is triggered, it turns into a market order. In a volatile quick moving market, the stop price could be acquired and the next offer price could be executed substantially well beneath that stop price and it will result in larger losses than initially expected, which is exactly what you were trying to avoid in the first place by using the stop order.
To recap, try to avoid getting stopped out prematurely, you always want to give yourself some wiggle room in regards to your stop loss entries. Otherwise you risk getting stopped out and missing the move entirely, even worse, handing yourself a realized loss costing you money.
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