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The Circuit Breaker Part 1

It is impossible for traders whether amateur or professional regardless of experience to avoid losing trades.  If you trade enough you will lose some trades it is just the law of averages.  However unlike amateurs experienced traders are cognizant of this inevitability of losing and are able to accept losses without emotional upheaval.  The difference is that the experienced trader has a systematic method to ensure those losses are kept to a minimum the amateur trader does not. 

Every trader should employ a losslimit system to limit losses to a fixed percentage of a portfolio's value or a fixed percentage loss on each trade. Think of each trade as a circuit breaker that will trip off and shut the trade down if it goes too much against you.  It is a safety measure so you do not shock yourself beyond recovery.  With a loss limit system in place exiting a losing position is an unemotional decision that is not affected by any hopes that the stock will turn around in your favor any minute now. 

Loss Limits Based on Percentage
Your losslimit system should be implemented before entering each trade. Before entering the trade you should simultaneously calculate how much downside in the stock you can tolerate without breaching your loss rule. After establishing your position you would then place a stop loss order within a maximum of say 1% loss of the total available balance in your trading account (your risk capital). Of course your stop can be tighter than 1% but remember tighter stops increase the chance of many small losses as a result of those stops getting filled.  Looser stops involve more risk but they will keep you in the trade longer.  Regardless of the size of your capital it is always wise to be conservative rather than aggressive when first devising your trading system. 

If you use STHQ recommended 10% position size on any one trade then your stop could be 10% below your purchase price on each trade and that would equal a maximum of 1% loss to your overall portfolio.  This is only a guideline you can devise your system with tighter stops and bigger positions or smaller positions with looser stops.  This is always subject to each individuals trading style and risk tolerance.







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