What to Consider When Setting an Initial STOP LOSS

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Where and when are we going to exit a stock if we’re wrong?

Unfortunately, this is a question many of us overlook until it’s too late.  Most of us only consider the upside potential when we’re buying a stock (at least that’s how I used to think when I first started).  If we don’t know where we’re going to exit if we’re wrong, then by default we are risking everything!

Actually, lets play this out…

Let’s say we’re interested in NFLX which has been on fire as of this writing.  It’s presently trading at about $315.  We do our analysis and based on what we’ve found, we determine that it has upside potential to +$700!  We decide to buy it right now at its high of $315.  We are so confident that NFLX will continue to rise that we don’t set a stop loss, nor do we consider where we’ll exit if NFLX comes back down… in fact, we tell ourselves that we hope NFLX does fall down to $200 so we can BUY MORE at this cheaper price!

Several weeks go by and we see NFLX climb steadily higher… it hits $400/share!  Then…something starts to happen.  It got ahead of itself.  It starts to pull back.  We think about buying some more shares as it hits the 21ema which is now at around $350.  

We double our position at $350 sure that this is a momentary pullback… we were right the first time.  We’re smarter than everyone else.  The market is wrong!  

Tomorrow NFLX starts to rally…

It gets up to $355. YES, we did it again!  WE KNEW IT!

We go out to lunch and by the time we come back, NFLX has reversed and is now trading at $345… no worries, by the end of the day it will climb higher…  we are right again!  NFLX closes at $349, just below the 21ema…

The next day NFLX gaps down to $325.  What’s wrong??  We start googling for news, checking our social streams.  We want to know WHY this is happening.  

Meanwhile, as we are trying to figure out why NFLX gapped down, it is now at $315 and is resting on the 50dma… Hmmm…based on what we know about technical analysis, institutions tend to step in at the 50dma and defend their positions… THIS IS A BUYING OPPORTUNITY!  We buy some more shares.

NFLX closes the day and closes the week sitting right on the 50dma.  We’re excited to have gotten in at such a good price…but now we’re also a little anxious too… during our search of WHY the sudden drop occurred, we found 5 solid reasons for it, but we also found another 5 people who were saying that this was just a momentary pullback and that NFLX was destined to rebound… The people suggesting that NFLX is destined to rebound are clearly right and our confidence is bolstered!  We sleep soundly that night and through the weekend.

Monday morning comes and “Murphy’s Law” occurs… NFLX and the market as a whole are down and down big.  NFLX is now trading at about $260!  We see someone mentioning how dramatically overvalued NFLX is as it is trading at a PE of over 200.  We never considered PE before BUT maybe this guy is on to something… we start to worry.

By mid-afternoon NFLX is down to $250 and the 200dma is in sight.  We look at the chart and notice that NFLX has traded above the 200dma since 10/2016 AND it received support at it when it approached it in July and November 2017!  We take a sigh of relief… We’ll just hold it for now and see what happens.

Has this ever happened to you?  

Have these types of thoughts ever crossed your mind?  If so, what has been the result?

How to set an Initial Stop Loss

In the video above I discuss the 3 main things I consider when setting an initial stop loss.  It is esstential to ALWAYS figure out what the stop loss is going to be BEFORE entering the trade.  It’s a great way to keep emotions in check and not fly by the seat of our pants.

The 3 main things I consider when setting a stop loss are:

  1. Where is support
  2. How is the stock behaving around moving averages
  3. What is the distance between where I plan to enter, and where I’m planning to set my stop loss.

These 3 elements combined have helped me not lose my shirt, not lose ground when I do have losses, and be able to use the true secret ingredient to long-term success…compounding!  It also helps me figure out my Position Size, which is another major contributor to success in the stock market.  

So check out the video and leave a comment down below letting me know what you thought, if you’ve had a NFLX story of your own, and if you use stop losses in your own trading.

 

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