Lots of traders do not know where to take a stop loss. This article discuses where to take stop loss.
85% of the traders who enter the stock trading business (not stock investment business) start with day trading. In India it is known as Intraday trading.
The reason is pretty simple.
They know that risk is involved in derivative trading. Derivative trading is trading options and futures. They start with Intraday equity trading. Once they start making losses they enter into derivative trading. In both the trading losses are there, therefore they do not want to take the position forward and try day trading.
Moreover the satisfaction of day trading, to see they made (or lost) money each day excites them. However they forget that making money is important. Whether it is made from positional trading or day trading is not important. They realize this fact only after losing money.
More Intraday traders lose money than positional traders. In Intraday trading money has to be made the same day or within hours, however in positional trading the trader has one month or more to make money.
Do you know even stock investments for long term is positional trading? For example if Ravi invests Rs.10,000 in a stock 40 years ago and when he reaches retirement sells that stock at 800 crores which is absolutely tax free, then this is positional trading. This is possible read this: How to Make Crores from the Stock Markets.
For positional trading in long term investments stop loss is not required. However for equity or derivative trading stop loss is required.
Some people do take stop loss in long term equity trading also. Like holding a stock for six months but then selling it at a loss of 10%. This is stop your loss.
For derivative and short term equity traders stop loss is very important. In fact it is compulsory. You cannot be in the game if you do not take a stop loss somewhere.
This article discusses where to take a stop loss.
Whenever traders read some bad news about a sector or a company they tend to believe that their stock may fall. Intraday traders short the stock in equity markets and positional traders may short a future or buy a put. What strike put they buy is their decision. But it is seen on most days that most active options are at the money options. This means most option sellers or buyers will trade the ATM options. So most option traders buy ATM puts if they feel the stock may fall.
Short selling is selling a stock that the trader does not own. But they have to buy it back one day. Derivatives traders have time to buy it back before or on expiry day. However equity traders have to buy it back the same day. Positional short selling in equity is not allowed in India, only Intraday is allowed.
Difference Between First Buy Then Sell And First Sell Then Buy
When a trader buys a stock or option all they want is Buy Low – Sell High.
Similarly when a trader sells a stock or option all they want is Sell High – Buy Low.
If the above happens it is profit, else it is a loss.
Who Are The Biggest Short Sellers
The biggest short sellers are the institutional investors. They short sell to hedge their positions. Among institutional investors hedge funds are the most active short sellers.
They use short selling mostly buying puts, not shorting calls, in some stocks that they hold to hedge their long positions in these stocks.
This strategy is known as married put.
But Where Do They Take A Stop Loss?
Institutional investors and hedge fund managers know very well their risk appetite. Unlike retail traders non of their trades are without a plan. Retail traders if they short do not do anything if the stock keeps rising. They trade on hope. Trading on hope and without a plan is not trading, it is gambling. All speculative trading is gambling.
How many times retail traders buy an option and see it expire worthless? This is the case with most new comers in option trading.
Do not let this happen. Never even average your buy position in options if it is making a loss.
All your money will go down the drain – it will become ZERO.
Decide a stop loss position and exit there.
Hedge funds also have a plan. It is obvious what they do is not known to anyone.
But I am sure this is what they do:
Suppose they have 10 crores worth shares of XYZ company and they fear it will fall.
These are the things hedge fund managers may do when they fear a fall in the stocks they hold:
1) They may short sell shares of another company in the same sector to the value up to 10% of their current share holdings.
2) Buy puts to the extent of 5% of the current holdings. In this situation it is 50 lakhs. They may take a stop loss at 25 lakh. Which means all they are putting at risk is just 0.25% of their holdings.
3) Sell Futures with a proper stop loss (though this they do rarely).
As you can see they have a proper money management plan they succeed to make millions from trading.
In US hedge funds are very popular, however in India hedge funds are not that popular. Equity mutual funds are very popular. If you do not know how to select stocks or mutual funds for the long term you can do my course here:
Where Should A Retail Trader Take A Stop Loss?
If you keep your profits at 5% then your stop loss should be at 2.5% of the margin blocked.
If you are successful 10 times trading, it will take 20 times for you to get back to no profit no loss zone.
As you can see with such a simple planning in place your trading results will become better than what it is now without a proper money management plan.
Hope this article helps you in deciding taking a stop loss while trading stock markets.
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