Should You Use A Stop Loss?
Stop losses are the easiest way to manage risk when trading, but you will be surprised that not all profitable traders use these orders to exit losing positions.
There are certain cases where using a SL can harm profitability, in which case it is understandable to reject the notion that a stop loss is every trader’s savior.
Before continuing, it must be said that in the vast majority of cases, a trader should include stop losses in their strategy.
If you are not sure, here is what you should consider before deciding.
1. How often do you look at the market?
Are you in front of your computer 16 hours a day, 5 days a week? Or do you only check the market once every few days?
If you are watching the market constantly, it possible to trade without a stop loss because you can catch any adverse moves against your position and exit trades manually.
If you do not check the market frequently, the market can move a great deal against you during those intervals. Therefore the best approach is to set a stop loss on all your positions to limit potential damage to your capital.
As a general rule, the more often you check the market, the less a SL is needed.
2. What method will you use to manage risk instead?
3. What is the win % of your strategy?
Your win % determines the probability of losing trades. A very high win % means you don’t have to worry about a losing trade often, so a SL is not vital. A low win % means most trades will be losers, so it is probably best to use a stop loss to get out ASAP.
4. Method of analysis
Are you a technical, fundamental, or quantitative trader? Each type usually takes different periods to play out.
Quantitative trading is high-speed – trades are opened and closed constantly. Because of the inherit risk of having many positions open and the fact that algorithms control trade execution, stop losses are usually used in some form.
Technical analysis is applied to all time horizons, and the visual patterns give an objective indication of where a stop loss should go. Because of this SL’s are typical.
Fundamental analysis is more subjective and often takes a long time to play out, making stops less popular than the other trader types.
To summarize, the higher the objectivity of the approach, the more common it is to use a SL.
5. Test it out!
All that matters is what makes the most money. After considering all the above points, backtest your strategy with and without a stop loss, and see what brings the best results.
I must highlight that even the consistently profitable traders out there who do not use a SL, still have methods to manage risk.
It is also more challenging to find an edge in the market without using a stop loss, so if you enjoy the path of least resistance, rather use this order to protect your downside.
Risk management is a non-negotiable pillar of successful trading. However, a stop loss doesn’t have to be a part of that.
Most traders should use a stop loss to control risk. If you are unsure, here are some questions that can help you conclude:
- Do you look at the market frequently?
- If you don’t use a SL, how will you manage risk?
- What is your win percentage?
- How do you analyze the market?