Share Market Toolbox
How to protect investment capital and minimise losses?
Stop Loss, Initial Stop, Trailing StopOkay, you have some money invested in shares, or a managed fund, or
some other financial instrument (eg. bonds, currencies, commodities),
and the value of your investment is falling.
What if the value of your
investment falls by 50% or more? or 90%?
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Stop Loss - what is it?
A Stop Loss is a price level at which you would consider selling your investment. It's purpose is to protect your investment capital by protecting profits, and limiting losses.
Example#1 - BNB (Babcock n Brown)
Take a look at the price chart of Babcock and Brown (code:BNB) at right - click on the image for a larger version that is easier to see.
Take a look at the price chart of Telstra (code:TLS) at right - click on the image for a larger version that is easier to see.
How to calculate a Stop Loss level?
Unfortunately, there are many correct answers to this question, and they are all different. Just some of the possible methods (with comments) include:
ATR chart indicators to determine a Stop Loss
Some people believe that an automatic approach to calculating the Stop Loss position, is simple, and as good as any. By using a technical chart indicator, your price chart can be automatically updated each day you look at it, and the value to use for the Stop Loss is shown on the chart without having to think about it. It is clear-cut, and there is no subjectivity.
More InformationSlide presentations - There is some preliminary and basic information in some of the slide presentations that Robert has prepared and delivered at various meetings.
TerminologyThere are a number of terms that are used in the text at left, including: Stop Loss, Support, Parabolic-SAR.
There is information on these in Brainy's eBook Articles. See the Master Index list for details.
Or, search the eBook Articles.
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Many of the available chart indicators for stops are based on Average True Range (ATR). The ATR is a dollar value which describes how far up and down the share price has fluctuated in recent trading sessions. A common default value is to calculate the ATR over a 14-day period on a daily chart (or over 14 weeks on a weekly chart).
For example, let's look at a weekly chart of BHP as in the sample price chart at right with the share price shown as candlesticks in the lower half and the ATR indicator in the upper half (click on the chart for a larger image).
Note that BHP was trading between about $35 and $50 until it crashed to $25. The ATR indicator in the upper portion of the diagram shows that the BHP share price was moving from week to week within a range of about $3 to $3.30, and then the ATR value increased to over $4 with the volatile share price move downwards in September-October.
The calculation for ATR is not a simple and straightforward calculation; but the chart indicators do all the calculating for us. The second diagram at right is a weekly line chart of the Macquarie Group share price in 2009 as it raced upwards from below $20 to above $55 (click on the chart image for a larger version).
The row of dots that rises across the chart is the Wilson ATR Trailing Stop chart indicator, based on a multiple of the ATR value of Macquarie Group. The idea is that near the right-end of the chart in early October 2009 when the share price was in the $50 range, the row of dots is positioned at $49.13, and basically says "if the share price falls to this value tomorrow, then the Stop Loss value is triggered and we should sell". This indicator can be easily adjusted to cope with more volatile, or less volatile, stocks.
Chart indicators for stopsSome of the more common chart indicators that are used to determine Stop Loss levels include the following:
This is the first Stop Loss level that is calculated at purchase time. It's purpose is to identify the point at which you would exit the stock if the purchase decision turns out to be a bad one. Traders tend to purchase a stock in the anticipation of a rise in price. But if the price falls, and the purchase decision is proven wrong, then it might be prudent to exit the position promptly.
After a stock purchase, and after the share price rises far enough, it is time to take the Initial Stop position and raise it to protect some of the earned profits. It then becomes a Trailing Stop, and it should be reviewed and raised every few days (or every week or two) to continue to protect more and more profit.
Implementing your Stop Loss
In order to implement a Stop Loss, there are two basic approaches:
More information?For more details about Stop Loss, see the Share Market Toolbox links at the top of the column at right.
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