Setting Smart Stops When it Comes to Investing

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Intelligent risk management means using stops. If a trader constantly gets stopped out, however, he/she may develop an aversion to using stops.images

They blame the stop, but the problem is usually the fact that are not setting smart stops.

It often starts with a sloppy entry. After entering in no-man’s land the trader then places a standard stop or a tighter-than-usual stop, which virtually guarantees a stop out.

For example, during a trade-along with a coaching client, I heard him say, “I got in late on that so I tightened up my stop.”

I replied, “You are about to follow one mistake with another.”

His first mistake was not entering in a timely manner. In the heat of the moment we may hesitate, over-analyze, worry, etc. When we finally act, the market has already moved out of our strike zone, but we execute the trade anyway.

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This happens to all of us. It’s the next thing we do that separates the successful traders from the breakeven and losing traders.

mistakes of investingWhen amateur traders realize they have made an entry error, they tend to tighten up mentally and emotionally.

They switch to defensive mindset, micromanage the trade and tightening their stop. Tightening one’s stop after a poor entry virtually guarantees a rapid stop out from mere noise.

When you make an entry error, the smarter option is to: 1) get out immediately, or 2) place your stop at the point at which you would have placed it had you entered properly.

Poor entries increase risk. If you can’t accept that risk, then don’t enter in the first place or just get out quickly. If you decide to stay in, don’t make a bad situation worse by getting defensive. Assume the larger risk and manage it rationally.

Until next time,

Kenneth Reid

Dr. Kenneth Reid holds a Ph.D. in Clinical Psychology. He is currently a trading coach and has published articles for Forbes, SmartMoney, and SFO Magazine. He has also appeared on CNBC and writes a column on The Trading Psychology for Trader Planet. Kenneth Specialized in trading stock and futures and is working on a futures trading book.