How to Use Stop Losses in Your Trading

Hi, this is Vijay Bhambwani and I am glad to be back with you.

This time let me start by thanking you for all the feedback that you have given me.

These videos are for you. The entire exercise is to help you become better traders. So when you give me your feedback, it pleases us no end. Everything is welcome. Your suggestions for what you want in our future videos, your appreciation, and even your criticism is all welcome.

This particular video is dedicated to the request that I have repeat repeatedly received from my viewers and subscribers about how to place stop losses on your trades.

Stop losses, as we all know, enable us to basically limit the amount of setback that we are willing to take.

But is it really as simple as that? I think not.

Stop losses are of various types and as Warren Buffett says in his annual meetings, he has often asked the question, when do you exit a stock? His answer is very simple.

In Berkshire Hathaway, we invest in a stock when the underlying reason that convinces us to invest is present and we exit only after that underlying reason is no more present.

So the stop loss that you place will also depend on the reason why you entered into the trade in the first place. So I go with a few types of stop losses and I clarify on what kind of stop losses you can place when.

if you're a day trader, the first thing is that time is your stop loss.

Which means, in the equity market, which opens at 9:15 AM and shuts at 3:30 PM, in the currency market, which opens at 9 AM and shuts 5 PM, and in the commodity market, which opens at 9 AM and shuts at 12 midnight, the market closing itself is your stop loss.

Day traders like to go flat out, which means square up their possessions no matter what, whether it's a profit or a loss and just like the ECG of a dead person shows a straight line, you go flat out irrespective of the outcome.

On the other hand, there are certain types of traders who are called micro trend traders. Now these are traders who typically do not allow a trade to last beyond 59 minutes and 59 seconds by the stop watch. So in such a case, the one hour time limit is also your stop loss.

You may have a query about what happens if the trade neither hits a stop loss, nor hits a target price in that one hour period.

The answer is very simple. The reason you kept the time stop was to exit at that time duration. If you like the trade, by all means, exit when 60 minutes are over and reinitiate the trade. That keeps you under check and lets you stay within the emotional parameters and disallows you from getting extremely aggressive in a trade.

I understand that exiting and re-entering and trade entails costs. Nobody would know better than me because I am a very cost sensitive trader, as have talked about in the trade efficiency ratio video. You need to keep your trading and execution cost low.

But a time stop is a time stop.

So I've tackled two kinds of time stops. For a day trader, end of the session. For a micro trend trader, 60 minutes.

Now let's take the other kind of stop losses.

If you are beginning the session, we all want to make profits but it is super critical, the day's first trade results in a profit.

That sets you on the right foot. You're basically cheerful. Your confidence level soars and then you can trade the remaining part of the day with increasing amount of ease.

However, if the first trade is not a profitable one, make sure that you do not lose any more than 2% of your capital or as we professional traders call it, your float, or your bank, which is amount of money that you set aside and put in the account of the broker to enable you to trade. Do not lose more than 2% of your capital on a trade.

On the other hand, if the first trade is happily, a profitable one, your stop loss on the next one will be slightly unique.

Now, this is a system that I follow. Feel free to differ. So if my first trade gives me a Rs 5,000 profit, on my next trade, my stop loss will be no more than what allows me to lose more than Rs 5,000.

The reason is very simple. I am willing to lose what I have made but after having a profitable trade, I don't want to have a loss of a second trade which actually eats into my capital. I am willing to go home with zero profit - zero loss.

But after making a profit, I will not go home with a net loss. I don't want to go out of pocket.

The other kind of a stop loss which is based on technical parameters. Remember what I talked about Berkshire Hathaway's investment philosophy? You have entered a trade based on a technical signal, which is a support or a resistance. If it all that signal is violated, you will enforce a stop loss and exit the trade. Since the very reason for entering a trade is no more valid now, you will shut out that trade.

Another kind of a stop loss is a stop loss based on screen reading signals. I have talked about the volume weighted price window and the snap quote window. I will stick to the snap quote window right now. So if at all, you click on F5, after highlighting any security, you will have a rectangular snap quote window on your screen.

If you have entered long because the last traded price is consistently trading above the average traded price, and you hold on to that position, as long as the price is above the average traded price, you're in the trade. If the last traded price falls below the average traded price, your stop loss is hit.

On the short side, you've entered a short sell because the average traded price was higher and the last traded price was lower. As and when the last traded price rises above the average traded price, you hit a stop loss and you're out of the trade.

The last kind of a stop loss is an event based stop loss.

If it all I have entered a trade based on a certain event, for example, the drone attack on Saudi Aramco, or killing of the Iranian General, which occurred in January, if it all I have entered, hypothetically speaking, I have entered long on crude oil because Saudi Aramco was attacked by drones or General Suleimani was killed by a drone strike, if I have gone long but I realise that the price is not rising anymore.

So the event is negated. In that case again, a stop loss is hit and I have no reason to stick around in the trade.

So these are the various types of stop losses that you can keep. As you can see, a stop loss goes beyond the simplistic understanding of trying to get out of a loss. Various stop losses, depending on various situations.

Before I sign off for the day, let me remind you to click like on this video if you're watching it on YouTube.

By all means, please share this knowledge by sharing this video with your family and friends. In the comments section, please tell me what you think about this video and what other videos you would like me to record for you in the future.

This is Vijay Bhambwani signing off for now. Till we meet again, please do take very good care of your trades and investments.

Thank you.