Jun.08, 2010
One great way of playing the market is by using a trailing stop to simply follow the stock up. A trailing stop is ideal because it follows the stock up when the stock does go up, but it does not pull back as the stock pulls back. This allows you to limit your losses and secure your gains.
There are a ton of advantages to using trailing stops.
1. It Limits Your Losses
Everybody has wins and losses. They key is to limit any losses that you do have. This way any loss you do have will play a minimum role in your overall return.
If you decided to place a 10% stop for instance you would be risking only 10% of the investment that you just made. If the stock suddenly pulled back 50% you would get out near the top and could wait for it to turn around before getting back in.
2. It Does Not Limit Gains
A second advantage of using trailing stops is that it does not limit the potential gain of the position. If you bought a stock and placed a 10% stop loss on it you would not be limiting your gains, only your losses. The stock could double and you would still be in it. Only once the stock starts to turn around 10% or more would your stop be activated and your position would be sold.
3. Takes Emotions Out
Emotions have a big impact on our trading. We want to hold onto a stock when it is going up and we want to keep holding on and convince ourselves everything will be ok when it is crashing.
Sometimes you can create your own plan of action and end up side stepping that plan because you got scared. Well the great thing about trailing stops is that they are automated. You just have to set them up and then forget about them.
The trailing stop will follow the stock up and the trailing stop will eventually get you out of the position (hopefully for a profit). The only thing you need to do is to figure out how far behind you want to trail the stock and then walk away.
This is a perfect way to “stick to the game plan” when you cannot trust yourself to do it.
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