When a trader starts his new venture into trading or
investing, he finds out many things that need to be
learned, understood and used as part of his tools to become
successful. One of the useful tools in many trading
software is the use of stop loss orders. Although this a
standard tool, not many use them. Some use them in
different ways to try to achieve one goal: profitability.
However, some use mental stop, a method in which a trader
determines a stop loss (either in dollar amount, percentage
or point system) in his mind but not physically place it in
the trading platform. Whereas the physical stop order is
placed in the platform on the broker's server or directly
on the exchange. What is the difference between the two and
what are the advantages and disadvantages of using either?
Advantages and disadvantages of using physical stops:
1. Placing physical stops remove the stress that normally
accompanies the trade. Once it's placed, there is usually a
sense of relief that the risk is known and cannot be
changed. This advantage is due to the removal from having
to think and guess what to do next during the trade.
2. Mental stops give the trader greater flexibility that
may fit his trading style where adjustments can be made
according to changing market conditions. This requires
thorough understanding of price action to be able to use
this flexibility.
3. Mental stops are difficult to implement for those who
lack discipline and concentration. Discipline is the
biggest obstacle for a trader to execute his planned mental
stops during the trade. Many cannot cope with the fast
action of the market, handling a losing situation, or
cannot even stay focused with the trading plan before the
trade. This cause the wish-washy decision-making that
inhibit the trader from sticking to his original mental
stop. Many times, the final stop loss ends up very far off
the original stop planned, thus a larger loss than planned
or expected.
4. Physical stops can be a disadvantage in markets that are
prone to stop-hunting, a method used by floor traders,
market makers, or highly capitalized traders to move market
to prices where high concentration of stop loss orders are
placed. Be they in stocks, futures or commodities and forex
markets, all markets are vulnerable to them, especially
where liquidity is low. This is especially true in stocks
during lunch hour where volume is thin or stocks that have
low daily average volume.
5. Physical stops protect traders from unexpected disasters
and mishaps they routinely suffer. When the stop loss order
is placed, it is parked at the broker's server or at the
exchange, depending on the instrument and the exchange in
which the trade is made. Having this order placed away from
the trader's computer, this will protect from outages,
internet connectivity problems, trading software problems,
or even the trader must attend to other priorities away
from the trading desk.
6. Using mental stops can keep the trader's focus in the
trade and not be distracted with anything else. Physical
stops are in place will cause the trader to be less
attentive to the trade and market at hand, causing him to
tend to other things besides trading. Concentration and
focus may suffer. If the trader must stay focused for the
subsequent trades, concentration is a must; else he may
miss important information that goes between trades.
It is always recommended that the novice traders use
physical stops entirely and unconditionally until he can
control his emotions and discipline. In additional, he
needs better understand the market before he can make rapid
and objective decisions in real time in order to be
flexible in using mental stops. The trader may not like the
idea of being stopped out just before the market goes his
way, leaving him out of the market. Each type of stops has
advantages and disadvantages, but stops must be seen as
insurance to keep his capital from major harm. It's a
difficult decision to make and only through trial and error
and assessing personal qualities or weakness will the
trader can determine which is best for him.
----------------------------------------------------
Larry Swing is the President of the popular day and swing
trading site http://www.mrswing.com a place where you can
find free daily articles and videos covering education,
market analysis and picks from Larry and other well known
traders in the industry.
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