Futures traders use stop losses to minimize financial risk and prevent unexpected catastrophe. A stop loss is like an insurance policy. As the name implies, its purpose is to stop losses. A powerful money management tool, stop losses allow the savvy futures trader to manage his losses, to keep them small and contained. Properly applied stop losses can mean the difference between success and failure for futures traders.
There are four basic stop loss methods:
Initial stop. The initial stop is your insurance policy against catastrophic loss. The initial stop is the pre-determined price point at which you will cut your losses and pull out of the trade. To be successful, a futures trader must have the discipline to immediately exit his position when the initial stop is triggered. There will be times when the market will rebound shortly after your exit; but far more often, your timely exit will prevent financial disaster.
Break-even stop. Break-even stops prevent you from losing more than your initial buy-in. Once your trade moves above your entry price, a break-even stop is placed at the entry point to prevent loss greater than the initial buy-in. Once you pass the break-even point, you start playing with the market’s money, not your own.
Trailing stop. Trailing stops keep your profits from slipping away. They allow you to ride a potentially profitable trade without risking your hard-earned profit. Trailing stops track the lows. As the market edges up and down in small steps, stops are placed just below each successive low. By riding the lows in a slowing rising market, you place yourself in a position to continually gain while maintaining an acceptably small level of risk.
Time stop. Time stops keep money flowing and prevent you from tying up your money in unprofitable trades. A time stop forces you to sell if a trade hasn’t reached its price objective within a set period of time, generally not more than one to two hours and usually less. Time is money. If a trade doesn’t produce, move on.
For more information on how to effectively use stop losses as a futures trader, click here to find out about my Futures Trading Secrets Course.