Let's understand stop loss

It's day 21 of learning about the stock market and living it. I've talked about my open contract for $NKE which I ended up closing today after looking at the support breakout yesterday. So, let's get some things out of the way and out my chest.

First, while making money in the stock market is a possibility and not far fetched, it is very important to understand that we can apply 10 different strategies and apply all the techniques known to men, but truly, no one can guarantee what will happen 100%. There are several factors that will influence the price of a stock and sometimes, we can get a curve ball and the price of a stock can rise or fall. The stock market is not always predictable, and maybe that's the beauty of it.

So, we know there are risks, and we know that sometimes a trades may not always yield to profit. What do we do about it? we minimize losses. How do we do? Through risk management.

What is risk management? It's a set of rules and techniques used to prevent extreme capital losses. I've heard winning is easy, it's minimizing the losing where the challenge comes in. As bad management and a sever loss can erase days, weeks, and even months of profit.

While there are different components to risk management, today we will focus on stop losses. What is a stop loss? a stop loss is when a trade is closed once a stock hits a target price. This target is set up by us as traders before a trade even begins, allowing us to be prepared for either gain or loss. So, let's have one example: I buy a stock at $150 per share, and I set the stop loss to be $140. This would indicate that the most I'm willing to lose is $10 per share. Typically when trading, this can be set up so that the exit of a trade is automated and if the price were to go below $140, I wouldn't lose more than $10 per share as the trading brokerage platform would sell my position at $140.

How can I apply this to my recently closed $NKE call option? I opened my contract on January 5 where the contract was $1.50. In call options, we multiply the contact by 100 shares to obtain the total investment. So, I paid $150 for it. If I wanted to only lose $20 we would do the following:

• Entry cost: $150 (the $1.50 per contract x 100 shares)
• Max loss: $20
• Loss per share: 20 / 100 = $0.20
• Stop loss price: $1.30 = ($1.50 - $0.20)

The way this would have worked is, if I set an alert, assuming it didn't automatically closed. I would set the contract stop loss at $1.30, which means that once this price per contract was reached, my trading brokerage would have closed the contract at his point.

The 13% Rule

By aiming to lose only $20 on a $150 trade, I would have been practicing a roughly 13% risk rule. This is a professional-level discipline. Most beginners make the mistake of "hoping" for a turnaround until they are down 50% or 80%, at which point the damage to their account is hard to repair.

Now, I didn't set up any stop losses before I entered this contract. As I mentioned in a few posts, this second trade was a revenge trade so the loss was rather maximum in my experience with no knowledge.

What did I learn?

I learned that aside from understanding the behavior of a stock's price, I also must set up the stop losses when entering a trade. Otherwise, I won't have any good risk management and will continue to be trading on a whim. Moving forward, I want to be more disciplined and I will do so by following my rules, including the 13% rule, and setting up stop losses to minimize losses and maximize gains.