Welcome back to part ten of our Foundations of Trading blog series, where we have been laying a foundational understanding of the stock market so everyone can have access to the world of trading. In today's blog, we are going to cover the topic of stops and how you can protect your trading profit with them. If you wish to review our previous blogs covering the Foundations of Trading classes, please click on the Foundations of Trading blog category on the right-hand side of the page. That will instantly bring up all the blogs from this series for you to review.
A stop order is a conditionally based order which is designed to protect your capital by exiting your position if a trade moves against you. It is a simple order that states if the stock on my open trade hits a predetermined dollar amount, exit the trade, and close my position. When the price point hits your dollar amount, a market order is issued, and your open position is closed. Usually, a stop order will trigger a market order when your stock hits a certain price. It will be the fastest to fill and exit you out of a trade. However, as with all market orders, the price point at which it executes might be slightly different than what you requested.
For example, you purchase ten shares of Disney, DIS, for one hundred dollars ($100.00) a share. Disney trades up to one hundred ten dollars ($110.00) a share. You believe Disney will continue to trade up, but to be on the safe side, you want to lock in some of the profit you have already acquired, so you set a stop order for one hundred eight dollars a ($108.00) share. That way, if the trade turns the other way and the stock drops in price, you have still locked in a profit of eight dollars a share. Also, using a two dollars margin gives the stock room to move without exiting you from the trade too early.
As with a market order, a stop-limit order will exit you out of a trade when your stock hits a prearranged price. You can decide ahead of time the exact price point you want; however, your order may not be filled due to price slippage. When the price point hits your dollar amount, a limit order is issued, and your open position is closed. Your requested price is guaranteed; however, finding someone to fulfill the other side of the trade is not always guaranteed. So, the order can remain open as the stock turns against you.
A trailing stop is designed to lock in profits while giving the stock room for growth. As the stock increases in price, a trailing stop can adjust itself accordingly based on a dollar amount or a percentage. If the stock turns and hits your stop market, it will automatically exit you from the trade and protect you from greater loss.
Regardless of the type of stop you use, all three of them will help you lock in any profits which have been generated on your current trade. However, as a guiding principle, you should set your stop where you know the current trade is no longer viable. A typical example of this is above or below a recent pivot point on your candlestick chart.
We also strongly recommend never expanding your stop to keep you in a trade. If a trade turns against you, let the stop trigger and take your hard-won profits. Stops are excellent tools to use when you want to protect your current profits while walking away from your trades to enjoy the rest of your day. Hope that helps, and we look forward to seeing you next week as we cover the core teaching of Foundations of Trading Level 3 Class 1.