The Stop Loss is a fundamental tool for trading activity, regardless of the market, investment style, and time approach (short-term, long-term, etc.).
Many, however, consider the Stop Loss like any other Risk Management tool, without giving it the right importance. It's important, therefore, to give credit to this crucial resource by listing the six reasons that justify its use. We will do this in the course of this article.
What is the Stop Loss
Before discussing the reasons that make the Stop Loss irreplaceable, it's good to give a definition of it that is as clear and exhaustive as possible, obviously for the benefit of beginners and those who have not yet started practicing trading in a conscious way.
The Stop Loss is the price reached at which the trader exits the market in a more or less automatic way. Obviously, there is not one Stop Loss, but several Stop Losses. It is the trader who decides it, based on evaluations regarding the extent of the risk to which he is exposing himself and the maximum loss he intends to accept.
There are tight Stop Losses and wide Stop Losses, conservative Stop Losses and courageous Stop Losses. Similarly, there are stable and dynamic ones (which change based on market performance). Regardless of the various types available, the Stop Loss always has the same purpose: to limit any losses, to make them acceptable and never out of control.
It is not easy to set a Stop Loss correctly. If it is too tight, it could cause exiting the market when the trade still has hopes of "getting back on track", thus causing a missed profit. On the other hand, if the Stop Loss is too wide, the losses could prove to be much more serious than expected, substantiating an objective damage for the trader.
Despite these difficulties, it is impossible or rather dangerous to give up the Stop Loss. The main reason is inherent in its purpose, but there are many others that can give an idea of its importance.
It allows you to control risk
If the Stop Loss is set well, or at least set according to criteria of sufficiency, then the Trader is equipped to deal with any type of risk. Even the most hectic market phase loses much of its intrinsic dangerousness. Very simply, the trader has a tool to exit the market "in time", before the market can cause unacceptable or even irreversible harm.
Obviously, it is up to the trader to decide the "amount" of risk he can afford. Based on this assessment, he opts for a tight Stop Loss, therefore close to the entry price, rather than a wide one, therefore far from the entry price.
It allows better money management
The Stop Loss is primarily a risk management tool, as it "normalizes" the market's ability to realize a loss. Since these are "economic" losses, however, the Stop Loss is also a money management tool.
Based on the definition of the Stop Loss, the trader has full control over the "worst case scenario", over the maximum loss that specific trade can cause.
It is no coincidence that the identification of the Stop Loss is closely linked to all the other activities attributable to Money Management, especially those that allow defining the investment for a single trade.
It is emotionally reassuring
This reason obviously has a psychological character. The Stop Loss is not only a risk containment tool, it is not only a money management tool, but it is also a resource to manage one's emotional sphere. There would be much to say about the importance and impact of emotions on trading, but those who have been practicing trading for some time obviously know what we are talking about.
Carrying out any trading activity means exposing oneself to a considerable emotional pressure. Firstly, because there is always the risk of losing, given the uncertainty that (at least apparently) dominates the market. Secondly, because the stakes are by definition high: one's capital.
In this context, the Stop Loss is configured as a tool capable of reassuring. The trader, if he has set the Stop Loss correctly or at least sufficiently, knows for sure that he cannot lose beyond a certain figure. This is a truly important advantage in psychological terms.
It allows a quick recovery of losses
One of the most serious problems that the trader has to face almost daily concerns the management of losses, not so much at the time of their formation but in the recovery phase. When a trade fails, the trader feels obliged to fill the loss, to recover what has been lost. This is a legitimate but at the same time physiological need. Now, if the loss was not excessive, that recovery is more within reach. The Stop Loss intervenes precisely from this point of view: it makes losses acceptable, keeps them under control, and creates the conditions for a quick recovery.
It allows you to automate exiting the market
This aspect mainly involves those who use the Stop Loss in the most intelligent way possible, that is, they associate setting activities with "automatic" use techniques. In this case, it is not up to the trader to exit the market once the Stop Loss is reached, but to a software capable of operating autonomously. Obviously, there are various degrees of automation, and the one that allows exiting in case of Stop Loss is certainly the most basic. Even this alone, however, is sufficient to relieve the trader of most of the work, both technical and emotional. Also because, as many traders know, exiting the market is easy and difficult at the same time. There is always the hope that events will turn out for the best.
