When to exit your trade is actually something of a controversial subject. There are some traders who insist that stop losses are there to be used – you should let your trade stop out if it’s not going the right way. Other traders are just as adamant about preventing losses by stopping out early – they say you should, of course, have a stop loss, but it should only be there as a failsafe.
Who’s right
Both points of view have their strengths and weaknesses – and probably the reality is that which one is “right” has more to do with the trader’s style than with any objective measure of whether stopping a loss as soon as possible is better than giving it room to recover.
The market has fluctuations, and it’s expected to correct a bit before ultimately driving towards where you expect it to go. This is why you can’t place your stop loss at your entry point; you’d be stopped out immediately and would never get a profitable trade.
Figuring out where to place your stop loss is a bit of an art of its own; but if you do so properly, the stop loss is going to be just on the other side of where the market would correct to before going towards your take profit. This would mean you have the minimum potential for loss and the maximum of profit.
On the other hand, you can’t really know where the market is going and saying that you can precisely determine where the market will turn around is about as absurd as saying you know where the market will be; if you know the market will go that far, why didn’t you take the opposite trade? Since the closer we place the stop loss, the more of our trades will be stopped out, there is a real risk to your profitability by putting the stop losses too close.
Having a broader stop loss and tracking the market allows you to take action when you can clearly see the market is going the wrong way and minimize your losses. You can’t know for sure where the market will go, but if your strategy gives you the reverse signal, you can become highly suspicious of your initial signal and get out.
On the other hand, the constant monitoring might lead to trouble; it’s more stressful, and if you have to step aside for a bit – for example, you are trading for a longer time period than just during the day – the market might go farther than you would have put your stop loss.
Since having a stop loss as a failsafe requires much more monitoring, it’s really best reserved for day trading; traders who leave their trades open overnight, for example, might feel more comfortable having a closer stop loss. This is why day traders often are the ones arguing more for the side of having a broader stop loss; while long-term traders insist on closer stop losses.
Whichever side you side with, there is still an important bottom line: always use a stop loss. A few – very few – can get away without them; but for the overall safety of your trading account, you should put in a stop loss at the very least as a fail safe. Stop losses are an intrinsic part of money management. A closer stop loss means you are more likely to have trades stop out, reducing potential profitability; a longer stop loss means your trades are more likely to run their course, but the losing ones will be bigger.
