Traditionally, an inexperienced trader will exit a position once they see a little bit of a profit in their trading account. They want to crystallize that profit immediately. People don`t like to lose, and they believe that those profits, made in the Stock Market, are their profits, and once they have them, they don`t want to risk giving them back to the Stock market.
Is the Stock market strategy written about in this article doomed to failure, since it breaks one of the cardinal rules of trading; to let your profits run? It is always wise to implement cardinal rules like this, but how do you implement this in the Stock market? Well, after you`ve defined your trading float, set your maximum loss, calculated your stop losses, and also calculated your position sizing – you can determine how to handle profits.
Once you`ve set your initial stop loss, you`ve ensured a mechanism to cut your losses short. Now you need to introduce a rule that allows your profits to run. By simply setting these two rules, you can control two important variables - whether or not you make a profit, and how much profit you`re going to make.
Of the two types of exits you use in the Stock market, hopefully it`s the ones we`re about to discuss now that you`ll get to implement more often, as these are the ones that are implemented once you`re in a profitable situation. Trailing stop losses will allow you to follow a trend as it develops in the Stock market, and exit the position at the point where you can realistically maximize your profits.
A simple example can illustrate the importance of a trailing stop loss. If you received a buy signal and purchased XYZ, and set your initial stop loss, you`d be sure to keep your losses small. But, your initial stop does not move. What happens if, after purchasing XYZ, the asset runs up a few hundred percent?
Unless you have a way to lock in the profit, you could keep that position until the share reverts all the way back down to your stop loss, where you would exit the trade. You would end up losing money even though there`s potential for some fantastic gains.
Obviously, you need to have a way to keep a situation like this from ever happening, and that`s exactly what a trailing stop does. This form of stop is adjusted on a periodic basis according to a mathematical formula that keeps it moving upward as the price moves upward.
After the first day of trading, if the price moves in your favour, or even if the shares volatility shrinks, then the trailing stop is moved in your favour. If the Stock Market then moved against you enough for your stop to be triggered, you would still take a loss, but it would not be as large as your initial stop loss.
The key to the trailing stop loss in the Stock market is that you need to adjust the asset continually to make sure that the stop is moved in your favour. A trailing stop loss is calculated in a way that is very similar to the way we calculated our initial stop loss. The only difference being rather than calculating our trailing stop loss from the entry price, we`re calculating our stop loss from the highest price since entry.
With a trailing stop loss in place, you will be able to let your profits run, and let your trading system deliver the maximum profit in the Stock Market.
By : David Jenyns
David Jenyns is recognized as the leading expert when it comes to designing profitable stock trading systems.Discover the "secret formula" of trading that anyone can use to consistently generate BIG profits from the market by downloading your FREE copy of David's new Ultimate Stock Trading Systems course.
Go here to download Stock Trading Systems ==> http://www.ultimate-trading-systems.com/stocks.htm