Trading Through a Correction – Part 1

Traders Trade Secrets –

 

Trading Through a Correction – Part 1
STOP & MOVE ON

Professionals do certain things all the time — every day — that help carry them through stock market corrections.  Today we’ll look at setting Trailing Stops.

Trailing Stops are one way to minimize the losses that come with sudden corrections.  In many ways Trailing Stops are a bullet-proof tactic because they are so arbitrary.  You simply set the Stop and then let it trigger automatically.

We like the idea of setting stops fairly tightly, say around -0.5%.  If you look at the math, you see why.

The goal here is to preserve your trading capital — especially during a run of losing trades.  If you set your Trailing Stops at -0.5%, you would need to take 200 losing trades in a row to empty your account.

Obviously, this is not going to happen.

More typically, traders go through a run of a few losing trades.  So, with stops at -0.5%, you could place 10 losing trades in a row and only lose 5% of your account.  (Assuming you typically trade the same dollar amount…)  And every trader should be able to take a 5% (or even 10% loss) in stride.

What Trailing Stops really do is very simple, they force you to “cut your losses and move on”.

Now let’s take a look at the other side.  Traders who don’t set conservative Trailing Stops very often tend to hang on the their losing trades for far too long.  They hope that the the price drop is temporary, that if they hang n there the stock will eventually bounce back.

Over the long run, the stock would probably rebound.  “Reversion to the mean” is one of the behaviors that has been proven to be prominent.  But if the overall market is in a state of “correction” your stock will likely continue to drop, or just settle in to a new lower price.

The real issue here is “how long will the stock take to rebound”.  Depending upon the size of the correction, it might take weeks, months, or even years.  This would either force you to sell and take a big loss, or leave your money tied up.far too long.

That is why we titled this article: “STOP & MOVE ON”.  Of course, what we really mean is “set your stops and keep trading”.  Professionals do not agonize over any one particular losing trade — BECAUSE THEY SET TIGHT STOPS — and never suffer a really big loss that actually hurts.

Remember, you will always and forever place losing trades.  The key is to keep those losses tiny.

the Editors

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