I have discussed my horizontal loss line on several occasions here because limiting losses is a key proponent in stock trading success. It all boils down to having a predefined rule about where to exit a trade if the original reason for entry is no longer valid. And whether you want to believe it or not there is no trading edge that is 100% foolproof. If someone tells you otherwise then you are being set up for a very hard fall.
I would be the first to tell you that I have a high probability trading edge BUT I also have a loss line because all trades do not work! Look at your loss rule(s) as an insurance policy. You have insurance in place just in case an accident happens. If you do not have accident insurance then disaster can be the result. Same with trading. Your insurance policy is your loss rule. My insurance policy against disaster is my horizontal loss line.
In developing my crosshairs software for public use I decided to design the loss line in such a way that it could appeal to both conservative and aggressive traders alike (because we are all different). Let’s take a look at a few charts and you can better understand what I mean.
CONSERVATIVE AND AGGRESSIVE
The following is a current DAILY chart of CTSH. You will see where my crosshair formed on several occasions to trigger a long trade 7/13/09, 10/06/09, 11/04/09, and then again yesterday. The vertical GREEN crosshair line indicates the entry. Then I have two horizontal lines as an exit strategy. The GREEN horizontal line closest to the price at entry is conservative and is there for the conservative trader who wants to limit possible losses to only a few points. The second, more aggressive horizontal line is BLACK and allows more room for the trade to work, but the risk is greater.
These allow the trader to make his or her own decision about where and when to take a loss and they are points to be considered and applied based on the risk tolerance of each trader. I simply use them as guides myself as a reminder that not all trades make money and that no two trades are the same. What need not change is the trader’s acceptance of loss as part of the equation. Let’s take a look at another example for the DAILY chart off CCJ.
Here, a RED crosshair triggered a short trade on 7/6/09. Depending on your profit target (which is another consideration altogether) you may have made some quick money on this one (from entry signal at 24.06 to the low of 22.61). If not, you again had two loss lines, a conservative one at the horizontal RED line (24.96) and then another at the horizontal BLACK line (26.46). Again just guides to be considered. Rules to be followed.
THE UGLY
Keeping with this same chart, if you had no loss rules and you entered a short trade here knowing that it had to work and you had to make a fortune on it, you would have lost money because as to this day the stock has never come back down anywhere near these lows.
Hanging on to a loser is a loser’s game. Your ego shouts at you to stay in because you know it has to work! Your predetermined, historically based, self-trusting, common sense rules whisper to you with a calm reassurance that this one may not make you money but you better have enough money to make the next trade that can. Just a thought.
