The importance of a STOP LOSS order : S/L

Being a successful investor is a game of patience and discipline. As an investor, you have two options- either learn discipline or keep taking occassional big hits.

In this post I am going to explain the importance of placing a stop loss order by two different methods.

The first method: (Plain suggestion): It is very important to keep a stop loss for any transaction you make. What that stop loss is going to be is for you to decide (before you enter that trade- not in between). Say for example you buy a stock for Rs. 100 thinking that it will reach 110. Ask yourself: if things turn out unfavourable, how much will this stock go down? The more your answer is based on some facts and research, the better. Say you think there is no way (or it is unlikely) that the price of this stock is going below 90/-. Then keep a stop loss of 90 or maybe 85 and stick to it ! If the price falls below 85 - Get the hell out ! It is natural for every investor to have a feeling of the type " ok , now the price has fallen to 85/-, its really low, no point selling it now. This stock can only go up from this point". Well. this is not investing. This is emotion. To summarize: Avoid emotions. Place a stop loss before entering a trade and follow it.

Here is the second method. I know that not all of you will follow this. But if you really want to take investing seriously i suggest you try this experiment.

Experiment : Set aside a couple of thousand rupees, an amount which you dont mind being paid for learning valuable investing lesssons. I had set aside Rs. 2500/-. Then try to do intraday trading without paying too much attention to stop loss. Keep a target that you must earn at least a couple of percent, say 5% of money and try to double this amount in about two weeks !

I will not disclose in this post what will be the result, or rather what experience I had, but believe me it is actually worth trying this. Not just reading. It will teach you the importance of discipline in investing much more than any blog post or a book can teach you.

To summarize the post, let me mention that there are three types of orders you can place.

  1. Limit order: You specify a price, and the trade will take place if the price is better than or equal to your price. (better means less if you are buying and more if you are selling).
  2. Market order: You simply trade at whatever the current market price is.
  3. Stop loss order (also called S/L order): This is a limit order where you automatically exit if your predecided stop loss is triggered.
When i said keep a stop loss, i do not mean that you should always actually place a 'stop loss order' on your online trading account. It could just be a 'manually triggered stop loss order', i.e. you keep watching the price and get out if it is worse than your pre-decided tolerable limit - or stop loss.

Jan 5, 2009

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