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Why Use Stop Orders?

     Most traders and investors don't use Stop Orders, but is this wise? Stop Orders can help an investor increase their returns, stem their losses, and reinforce the mechanical aspects of their trading strategy rather than being pulled around by their emotions. The logic behind the use of Stop Orders is simple: cut your losses to preserve your capital. Investors often overlook the fact that if the value of their investment declines it takes a greater increase to return their account balance to where it started. A small loss requires a slightly larger gain to be even again, but a large loss requires a Herculean increase just to get back to even. Most investors kill their chances of great returns by not stemming their losses. They're just fighting to get back to where they started. A 10% decline requires an 11% gain to get back to the same level, and a 15% decline requires a 17% gain. A 20% decline requires a fairly large 25% gain to just get back to even, and if an investor lets an investment slip 25% then they need a 33% gain to get back to where they started. Most investors are looking for a nice two or three digit return on their investments, not just an account with the same starting balance. There are three primary types of Stop Orders: brokerage firms offer two and one resides in the trader's head. A standard Stop Order is placed below a purchase price and is triggered when a stock declines to the specified stop level. A standard Stop Order becomes a market order when triggered, and will be executed at the prevailing market price with there being no guarantee of the price received. Stop Limit Orders turn into a Limit Order when the stop level is reached. With the Stop Limit Order the minimum execution price is known but in fast trending markets the prevailing price may be below the selected limit price and the sale may not get executed. The third type of Stop Order is the one manually calculated by the investor when they enter the position. The secret is to actually act on the mental stop when the price is reached. Wealthy traders will use their stop of choice, limit their losses, and move their capital into a more productive stock.

    We wish we could recommend which stop is appropriate to use, but there are a lot of factors that go into that decision. The best strategy is to note at what price you'll be down 10% on a stock, and if that price is hit, give your representative a call to get an updated opinion on the stock.


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