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The Biggest Mistake That Stock Traders Make

April 14, 2012 | Comments: 0 | Views: 123

Trading stocks can be a profitable way to either make a living or build up a retirement account. There is one factor that I believe is the biggest mistake a stock trader can make: failure to set a stop loss at the time the stock is purchased.

A stop loss is an order to sell a stock at a pre-defined price. E.g. If you bought 100 shares of XYZ Corp at $10. per share, you might place a stop loss to sell 100 shares at $9.50. This means that if the stock drops to $9.50 your 100 shares will automatically be sold. Sometimes the stock may be sold at a lower price if it gaps down at the market opening but at least you will have cut your losses.

Another way to set a stop loss is by using a trailing stop. This is an order to sell a stock at a certain percentage drop in the stock's price. If the stock moves up in price the trailing stop also moves up along with it. E.g. If you purchase 100 shares of XYZ Corp at $10. and set the trailing stop to 10%, the initial stop price will be $9.00. If the stock moves up to $12. the trailing stop will then be $10.80 (10% of $12 = $1.20. $12 - $1.20 = $10.80.) If the stock continues to rise in price your trailing stop will also rise with it. If the stock decreases in price the stop will remain set at %10 of the highest price reached by the stock. This method allows you to ride a stock up in price but also ensures that the stock will be sold at a profit if it then reverses in price.

The question is where should a stop loss be set? Using a trailing stop alleviates this problem as the stop price is automatically calculated. Setting a fixed price stop requires the trader to use chart analysis in order to determine an appropriate stop price. When first starting out trading It is probably better to use a trailing stop of 5-10% as it removes all guess work from the stop price calculation.

By setting a stop loss you are taking all emotion out of the trade as you have pre-defined your loss limit in advance. As Gordon Gekko said in the movie Wall Street: never get emotional about stocks.

Ralph Press, stockspaywell.com

Source: EzineArticles
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