Today we're going to talk about what is a stop loss and also what is a profit target - and why you should use it in your trading.
A few days ago I published a video about losing money in stocks. I received a comment that said, "this was really helpful but I don't know what a stop loss is."
Let’s get started. We’ll use Netflix as an example.
Let’s say that right now Netflix is trading at around $380. And let's say, you think that Netflix will continue to go higher.
If you were to buy the stock right now for $380, I’d recommend that you set a stop loss.
What does that mean, set a stop loss?
It means that you pick a level where you admit, if the stock goes there, you were wrong.
You've got to limit your losses because think about it, when trading there are 3 things that you need to do, right?
You need to pick the right stock. You need to know when to enter and let's say that you identify this as a good entry, and then you need to know when to exit.
And when it comes to exit, you need to know when to exit with a loss and when to exit with a profit.
So let's say you enter at 380 and think Netflix will go higher. You’d set your stop loss at 360. Meaning, if Netflix turns around and goes to 360, you get out.
You have to pick a level where you admit to yourself, "I'm wrong. I'm moving on and I'm keeping my losses small."
On the other hand, what is the profit target?
A profit target means that if it goes there, you're taking money off the table.
For Netflix, you might pick a value of 420, and if Netflix goes up there, you're taking money off the table.
Let’s say when you entered it keeps going down. This means they are getting stopped out. Meaning, you realize a loss, but it is a small loss.
If you’re trading one share, we’re only talking about $20. If you don't get out with a small loss, the small loss could quickly turn into a larger loss. The idea here is to risk a little.
Let’s say you're right, you’ll make more on your winning trades than you lose on your losing trades. That’s an important concept to understand.
I like to use the 'golden rule'
What does this mean?
The golden rule means that you risk a $100 trying to make $200. In our specific example for Netflix, you're risking $20 trying to make $40. Of course if you were trading multiple shares, this would be multiplied.
Here’s the cool thing, if you keep your losses small, and make more money on your winning trades than you risk on your losing trades, you can make money, even if you're wrong half of the time.
Always limit your risks by using a stop loss and profit target.
Stop Loss: You’re getting out of the trade if it moves against you, if you are wrong.
Profit Target: You’re taking profits off the table, if the trade moves in the right direction.
Here are 3 important things that you need when trading
- Finding the right stock to trade
- Know when to enter
- Know when to exit (with a profit, or with a loss)
If you would like to know more and go into detail, join us at one of our upcoming