Minimizing Risk for Long-Term Success
One of the fundamental goals of any successful, long-term trader is to effectively minimize risk. Managing risk is a key tenet of trading success, whether you are a novice or a seasoned veteran in the markets. Among the many tools and strategies available to manage risk, trading with a stop loss is one of the most crucial.
Before diving into a detailed discussion on the mechanics of stop losses—which we’ll explore at another time—it’s worth acknowledging that there are diverse approaches and schools of thought on their use. Some traders deride stop losses as a form of “death by a thousand cuts,” arguing that a true professional already has risk management integrated into their strategy. Scalpers, who focus on ultra-short-term trades, often claim that setting a stop loss while scanning for micro-breakouts is inefficient. The reality is that the utility of a stop loss depends on a variety of factors: what you trade, your trading style, how quickly you enter and exit positions, and how confident you are in your market knowledge.
One of the best analogies I’ve heard compares the use of a stop loss to a life vest in rough surf. As a trader, you’re like a surfer scanning the horizon for waves, repeatedly positioning yourself to catch the right one. Just as a surfer evaluates each wave’s potential, traders evaluate market opportunities. However, just as surfers inevitably fall, traders also face downturns or market shifts. In this analogy, a stop loss functions like a life vest—it’s there to prevent a major wipeout from becoming catastrophic. Without a stop loss, you might keep afloat for a while, but eventually, there will come a wave strong enough to pull you under.
Marty Schwartz put it best: “Learn to take losses. The most important thing in making money is not letting your losses get out of hand.”
For traders, especially those just starting, it’s worth considering a few personal anecdotes to underscore the importance of stop losses. The first scenario occurs when the market suddenly shifts or large volumes of shares are dumped, leaving you on the wrong side of a trade. A stop loss can prevent what could have been a jaw-dropping loss. The second scenario involves unexpected disruptions: an internet outage, computer malfunction, or even a distracted moment. Any of these can keep you from manually closing a position, and without a stop loss in place, you may end up facing significant losses. In these situations, the stop loss serves as a critical safety net—a life vest that saves you from financial drowning.
The idea is simple: by mastering the basics and implementing tools like stop losses, you can eliminate many avoidable pitfalls. While they may sometimes feel cumbersome or clunky, stop losses provide invaluable peace of mind and protection.
Ultimately, as Paul Tudor Jones wisely said, “You may think that trading is all about making money. Yes, the ultimate goal is to make money, but you can’t make a dime if you lose your capital. So, the primary goal is to protect your capital.”
In conclusion, whether you decide to make stop losses a key part of your trading strategy or not, I encourage you to explore and practice any trading approach that emphasizes risk management and preserves your capital. Wishing you much success and a long, prosperous journey in trading!