A good method can take you to heaven, but a bad strategy can leave you in a 'locked room.'
Being trapped may be one of the most feared terms for all trading novices, as it not only means losses in the account but also represents funds being stuck and unable to be used for other investments and trades.
In investment operations, there is a strategy known as 'setting stop-loss points.' If used wisely, it can prevent you from being trapped in a position. Today, we will explain how to execute an effective stop-loss strategy from both the technical and fundamental perspectives.
⊜ What is stop-loss?
The issue of stop-loss is indeed a frequently discussed topic in investment trading. As the name suggests, stop-loss is a means to stop losses. In investment trading, we have various ways to control risk, and setting stop-loss is one effective method.
Stop-loss is somewhat similar to the economic concept of 'sunk costs,' referring to costs that have already been paid but cannot be recovered. In investing, if a trade incurs losses, sometimes investors may hold on to avoid stopping losses, which is akin to sunk cost thinking, where one continues to invest to break even but may lead to greater losses.
For example, today you impulsively bought a movie ticket, but while browsing reviews online, you find that everyone thinks it’s a bad movie. At this point, whether or not you go to the theater to watch it, the money for the ticket cannot be recovered. Thus, the money you spent on the movie ticket is your sunk cost.
From an economic perspective, rational individuals should ignore sunk costs when making decisions. For example, when you find that the movie you are watching is of poor quality, the rational decision is not to consider the movie ticket you have already paid for, but to use your time for more meaningful activities.
The stop-loss strategy also follows this principle. When investors find that the expected outcome of their investment trades does not match their expectations, the rational approach is not to hold onto a wishful thinking mentality, but to quickly stop-loss, clearing out incorrect investments or trading positions to prevent further losses. This behavior is to protect funds and avoid falling into the 'sunk cost' thinking trap, thereby adapting better to market changes.
Stop-loss is a very important strategy in risk management. Below, we will explore how to set reasonable stop-loss points through technical and fundamental analysis.
Before this, let’s remember a major principle: when the reasons for buying disappear or reverse, it is often the best time to stop-loss.
(For 'stop-loss,' click to read: (Trading Secrets Revealed: 6 Legendary Trading Masters Share the Truth of Profit))
⊜ How to set stop-loss points using technical analysis?
Technical analysis is suitable for medium to short-term trading, or as an aid for observing long-term trends. In trend trading, technical analysis plays a very important role.
Here we have compiled several stop-loss methods related to technical analysis. There is no right or wrong among these methods; in fact, which indicators to use depends entirely on personal preference.
◓ Using technical indicators to determine stop-loss points: taking 'moving averages' as an example
Traders can use their preferred technical indicators to determine stop-loss points, and this article will take moving averages as an example.
The full name of moving averages is 'moving average lines,' a technical indicator that can quickly determine the average cost of all market investors over a certain period. It is also the source of all technical analysis, so using moving averages to set stop-loss points is quite popular.
Suppose we enter based on the 'moving average theory.' When the short-term moving average breaks above the long-term moving average, it indicates the establishment of a bullish trend and serves as a buy signal.
Regarding moving averages, Graham's Eight Principles are introduced in detail:
However, suppose the short moving average only breaks through for a day or two and then quickly falls back below the long moving average (sell point 3). This likely indicates that a true bullish trend has not actually formed (in this case, it may be a false breakout), so we can execute a stop-loss on the positions we bought in the previous two days.
You might say that the short moving average might reverse and break through the long moving average again! It doesn't necessarily mean you need to stop-loss, right? However, this is actually a form of wishful thinking, an irrational emotion that cannot abandon 'sunk costs.'
Technical analysis is a discipline that emphasizes investment discipline. If too much subjective prediction is included instead of following the established investment strategy, the outcome is usually not very good.
(For 'Graham's Eight Principles,' click to read: (Moving Average Secrets! 'Graham's Eight Principles' help you accurately capture buy and sell points))
◓ Using technical patterns for stop-loss: taking 'W' bottoms as an example
Technical patterns refer to when prices 'present a specific shape and pattern,' and traders use these patterns to judge whether the current price is in an upward or downward cycle.
Using the classic 'W' bottom as an example, the so-called 'W' bottom is when the price trend appears as a 'W' shape on the chart, as shown below:
In a W bottom, we can draw a neckline (the green line in the image) based on the peak of the first price rebound. Once the price breaks above this neckline, it indicates the potential for a significant increase in the future. The neckline can also serve as a basis for stop-loss; if the price breaks the neckline and quickly retreats, it indicates that the bottom has not yet formed, so a stop-loss can be considered.
Suppose we discover today that Company A's stock price has formed a W bottom on the technical chart and has broken through the neckline, indicating a bullish trend. Therefore, we decide to buy shares of Company A; however, if Company A's stock price subsequently quickly falls below the original neckline of the W bottom, it means the upward trend is not yet established. At this point, we can sell our holdings to stop-loss.
◓ Monetary stop-loss method: using the absolute loss amount as a proportion of total funds to set stop-loss points.
The monetary stop-loss method is quite simple; it just looks at what proportion of loss you can bear in this investment or trade. Once the loss reaches this proportion, you stop-loss and close your position, which is very suitable for those who do not yet understand technical indicators well, as it can prevent your account funds from plummeting.
For example, if your monetary stop-loss limit is 5%, it means you do not want this investment's losses to exceed 5% of your total account funds.
Suppose you invested 1 million yuan to buy stock A, but stock A's performance is worse than expected, and it drops 5% in a short time, reaching the threshold you set initially, so you choose to sell stock A to stop-loss.
The actual percentage setting for monetary stop-loss methods varies from person to person, depending on how much loss you can bear.
◓ Using risk-reward ratio to set stop-loss points.
The risk-reward ratio is based on the yields and risks you plan to set for take-profit and stop-loss, which is actually quite similar to the previous monetary stop-loss method but focuses more on the relationship between risk and profit rather than simply using loss amount as the stop-loss standard.
For example, if you expect a potential profit of 20% from stock A with a potential risk of 10%, the risk-reward ratio is 2:1=2.
Assuming the purchase cost is 10 yuan, and the stop-loss point is set at 10% while the take-profit point is set at 20.
⊝ Stop-loss point: 10 × (1-10%) = 9
⊝ Take profit point: 10 × (1+20%) = 12
In simple terms, the risk-reward ratio method is to analyze data and set stop-loss and take-profit points based on personal risk tolerance to decide the timing of exit.
The stop-loss methods mentioned above are just basic technical analysis methods; there are many deeper and more rigorous methods. For example, technical indicators don't necessarily have to use 'moving averages,' and technical patterns don't necessarily have to use 'W bottoms.' Traders can completely use methods or strategies they are more familiar with to set stop-loss points.
⊜ How to set stop-loss points using fundamental analysis
◓ Stop-loss can be executed when the reason for buying disappears
Taking stocks as an example, the so-called fundamentals involve observing and analyzing a company's growth status, operational conditions, and intrinsic value, thereby establishing an appropriate margin of safety to buy when the price is less than the value.
Fundamental analysts usually keep detailed records of their reasons for buying a company's stock. For example, the reasons for buying Company A's stock may include the following three points:
◍ The industry is trending, Company A is the third-largest in market share for this industry, and still has growth potential.
◍ Has an economic moat, making it difficult for competitors to catch up or requiring significant costs to do so.
◍ The company's financial statements are performing well, especially with free cash flow growing by 10% each year, which is particularly impressive.
Thus, the stop-loss points for Company A are actually the reverse of the three advantages mentioned above:
◍ The industry faces the risk of being replaced.
◍ The economic moat is gradually disappearing
◍ Free cash flow growth stagnates or even declines.
Fundamental analysts rarely sell stocks solely based on paper losses, because for them, if the company's 'health' hasn't changed, it means the intrinsic value hasn't changed. A drop in stock price may represent a good buying opportunity.
◓ When prices rise irrationally, you can also stop-loss.
Although the company's 'health' hasn't changed, if the stock price rises irrationally due to market sentiment, even exceeding intrinsic value, we can also consider selling the stock.
For example, if we analyze various data and financial reports and conclude that Company A's stock price should reasonably range between 50-60 yuan, but the market price has skyrocketed to over 100 yuan, at this point, you can consider selling your shares.
Such situations often occur before major market crashes. If fundamental analysts can observe the irrational sentiment in the market, they can avoid stock disasters (bubbles). For irrational prices, we can also observe overall market sentiment and risk using the 'Shiller P/E ratio' or 'Buffett Indicator.'
◓ When better investment opportunities arise, you can also stop-loss.
The third fundamental method for setting stop-loss points is when investors determine that there are better investment opportunities in the market, they can sell stocks they believe have poor growth potential to take cash and buy stocks they think have higher returns.
Suppose the growth potential of Company A over the past five years is 100%, but you find that Company B has a growth potential of 200% within the same period. In this case, we can liquidate the shares of Company A and invest in Company B.
You might say, this doesn't necessarily mean I have to stop-loss; I can use another fund to invest in that better opportunity!
But you should know that an individual's total funds are limited, and there are not many good investment opportunities in the market. To improve overall return rates, it is also important for fundamental analysts to maximize the 'profitability efficiency' of their investment funds.
⊜ What to do if you are trapped? Teach you three 'foolproof' methods to get out.
Anyone who trades, regardless of the duration, has experienced being trapped at least once. For those trapped, the most concerning issue is how to quickly get out. Being trapped is not scary; the key is to understand how to 'get out' and learn lessons and gain experience from it.
However, to get out, some skills are needed.
◓ Decisively close positions and exit
Whether it's stocks, stock index futures, or cryptocurrencies, when you are trapped and the market undergoes significant changes that alter your view of the future trend of the holding, especially for short-term traders, you should decisively cut losses and exit to stop losses.
When the market experiences extreme conditions, or you cannot determine the market direction, you should decisively stop-loss and exit, rather than holding on with a hopeful mentality.
However, in trading practice, cutting losses and exiting usually only happens with positions where the amount trapped is relatively small. Many aggressive traders, when heavily invested in a certain asset and facing losses, find it hard to let go and exit.
◓ Add to positions when prices are low, add to positions when prices are high
Repeatedly adding to positions when prices are low and reducing positions when prices are high can relatively increase the probability of getting out. However, this operation requires very high accuracy in timing the buy and sell points. Although averaging down is a passive response strategy after being trapped, it is not a good method for getting out. However, in certain specific situations, it can be the most suitable method.
This method is similar to 'inverse pyramid' or 'pyramid' style averaging down. The inverse pyramid style means that in the process of averaging down, each time you increase your position, the scale is greater than the previous position. This method is more suitable for investors who are trapped at high prices. The pyramid style means that each time you increase your position, the scale is half of the previous trading position.
Additionally, it should be emphasized that I personally strongly oppose ordinary traders using hedging through locking positions to avoid losses. Locking positions is a technical skill that requires profound expertise and experience. Sometimes, it's better to choose to cut losses than to lock positions.
◓ Patience to wait
This method may be relatively passive, generally suitable for long-term investors, waiting for the position to be resolved. Being friends with time may be where true human nature is tested.
Of course, for investors who buy stocks at high prices, it may take 3-5 years to break even, and this method also wastes time and hinders new investment opportunities. But for traders in stock index futures, their holding period is usually a maximum of 12 months, and during this period, they may need to switch contracts based on different products.
Old Li did not panic and stop-loss due to the price drop but seriously considered both fundamental and technical factors and believed that the market would continue to rise. Sure enough, after hitting a new low, it rebounded strongly, starting the longest rising trend of the year.
As the saying goes, losses are part of trading. Everyone makes mistakes in trading, and no one can profit every time. There are many articles and methods about getting out of a bad position online. Not all methods will suit you, but there will always be one that can help you. Trading is a continuous learning process; as long as you learn enough and solidly, you can achieve long-term profitability.
In the process of avoiding being trapped in a trade, we can focus on the following aspects:
First, conduct in-depth research on market trends, analyze accurately, and place orders according to the trend. As the saying goes, 'the trend is your best friend in trading,' which emphasizes the importance of trend analysis.
Secondly, develop good trading habits, including strictly planning your position, entry and exit points, stop-loss, and take-profit points before making trades, and executing decisively. Once a plan is made, you should adhere to the principles and not easily change them to ensure the discipline and execution of trading.
Finally, treat market conditions rationally. Do not rush to recover losses through counter-trend operations due to losses. Timely stop-loss and rationally turn around to keep calm. In trading, remember the principle of 'as long as the green mountains remain, one need not worry about firewood,' which means to maintain the safety of funds and operate steadily. Such rationality and discipline will help reduce the risk of being trapped in trading.
Don't slip away! You've seen this far; doesn't it deserve a follow for the late night I've endured? 😏
#大而美法案 #比特币巨鲸动向 #币安Alpha上新
Continued attention:$ETH $ETH