Set a predefined point at which you admit defeat and exit the trade.When you enter a position, you never know where you are in the trend. The trend might be in the middle of its run or at its end. That's why you must set your initial stop.
It's like saying, ‘If a particular trade doesn't do what I thought it would, I'm going to get out.’Generally, short-term traders will set their stops closer to the price, while longer term traders tend to give their trades a little more room to move.
Note: by setting your stop losses too tight, you'll decrease the reliability of your system because you'll get stopped out more often. Plus, the more you're in and out of trades, the higher your transaction costs.
There are many ways to set initial stops, such as technicals, indicators, percentages and more.Whatever you choose, the important thing is to just have something in place. Sure, you can always drive through that red light, but you risk getting wiped out by a semi-trailer!
After setting your initial stop, you need a method for calculating your position size so you never risk more than your predefined maximum loss.
There is a simple formula for calculating this:
maximum loss / initial stop size = number of units to purchase.
A basic but very powerful equation!
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