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Stop! Are you protecting your portfolio with trailing stops?

Joanna Kong
Yahoo Finance Premium

This detailed reporting was brought to you by Kim Ming Lam, Head of Hong Kong Research at Trading Central using Yahoo Finance Premium's Enhanced Charting feature. Click here to start your free trial* and step up your investing.

Traders — serious ones — have a saying (and religious belief): "If you don't use stops in trading, you'll soon stop trading."

First, let's do some fact-checking.

What percentage gain (rebound) would you have to make in order to "get even" after a loss of 10%? Answer: 11.1%.

After a loss of 30%? Answer: 43%.

Down 50%? Answer: 100%.

80%? Answer: 400% (not much chance of that in today’s markets).

So, what should you do to protect your capital from such erosion as much as you can? Cut your losses earlyor lock in profits earlyby using stops.

For every position that you take in the markets, try leveling up your habits by creating a trading plan that clearly states when you would exit the position. What is the maximum loss that you will bear? We suggest developing good exit techniques by considering the monitoring power of stops, which can help control the “fear and greed” that often develops during trading.

Stops provide an exit price that will limit losses if the price turns on you. The value is calculated at some distance below the current price for long positions.

Let’s take Apple Inc (AAPL) as an example, and look at its chart in Yahoo Finance Premium. Technical Events point out that the stock is showing upward momentum, calling for higher profit potential for your holding.

At the same time, you should be alerted on the downside to prevent uncontrolled loss — perhaps by using a stop.

With Yahoo Finance Premium, you can use the pre-calculated stop loss value as your starting point.

Apple chart showing bullish Technical Events and pre-calculated Stop loss.

The pre-calculated Stop loss value is determined using Trading Central’s volatility-adjusted algorithm for planning position exits. These stops seek to minimize risk for longs. The algorithm is based on a statistical analysis of the historical prices, using a price filter line algorithm with two different noise statistics. It’s meant to provide investors with a starting point for considering what a reasonable cutoff point for losses is.

Another approach is to use percentage-based stops to maintain a fixed percentage offset level (set by you). For example, you might decide to use 6% or 10% decline as your stop level. We offer the pre-calculated stop loss level for investors that are uncertain about what a reasonable percentage would be. This stop loss is based on the stock’s historical volatility so we can help you to assess how much “breathing room” is suitable for your position.

Many investors will take the stop loss principle further by adopting Trailing Stops. This is the practice of using that stop loss as a floor, but ratcheting up your stop level as the price makes gains. This allows you to monitor a price that will ultimately trigger you to exit with profits, when the price starts turning against you.

Having determined the downside you can tolerate, you can elect to execute your stop exits based on manual or automatic methods. While trading your exits manually, you must expect an additional slippage amount since there will be a time delay between the stop-trigger notification and the exit-trade execution.

In rapidly falling markets, this slippage can be very large.

Slippage would still occur with pre-entered orders. But unless the liquidity is very limited, slippage in this case is expected to be relatively less.

It is our sincere hope that this article can help you realize that, in every trade, the exit is equally as important as the entry when it comes to optimizing your overall portfolio success. Try out the stop loss feature by looking up a stock with Yahoo Finance Premium and opening its chart.

Happy Trading.

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