Stop the pain, take the happiness
To me, this is really a blend of theories, knowledge of the market as well as mostly luck.
Importantly, we need to know what is stop loss and take profit.
Stop loss is set on trading stocks to remind you to pull the plug when you were wrong about the anticipated direction of the market. Stop loss enables you to exit the market when a stock has fallen below your acceptable threshold and prevent you from losing more.
Take profit is for you to decide to exit the market after realizing considerable amount of profits for the investment made and more excitingly, it is to use the profit to pay for any major purchases, living expenses, or use the profits to build and fulfill your portfolio allocation strategy by putting them into another investment to earn even more.
There is some underlying principles in stop loss and take profit for example, 1) after you had purchased a stock at a price, it will not always shoot up right away. Therefore, giving it a bit of room to move before it starts to go up is essential instead of trying to achieve zero loss. Selling immediately upon a drop will also make you lose on commission and against your initial decision of the stock’s potential growth. Have some faith, as every investor wants to buy low and sell high, hence you need to give it chance to grow. The idea of a stop loss is meant to be a safe guard only whenever you made a very wrong expectation about the stock’s direction, but not for you to make knee jerk reaction, 2) likewise, do not sell a stock for profit just because the price had risen as you will be falling into the trap of taking a small win after a stock gained in value and neglecting future greater earnings and; 3) all “buy and hold” investors have the intent to buy stocks at the absolute bottom price but may not be always accurate. If you are caught in a downtrend, the stop-loss must be executed if the price continues to decline even after the purchase.
Next, I would also categorize stop loss and take profit into two areas namely micro and macro considerations with some fundamental rules.
For micro, there is a need to determine your present financial risk appetite figuratively. For example if you buy a stock at $1.00 and set stop loss at $0.94, then you have $0.06 of risk per share. If you have a position size of 1,000 shares, the total risk on your trade is $0.06 x 1,000 shares, which is $60 plus buy-sell commission. This can correspondingly increase depending on your appetite to lose. Generally, the amount put at risk should represent only a small portion of your total trading account like 2%, meaning if $60 risk is 2%, the your trading account should be about $3000. Some trading platforms have the trailing stop-loss order function, which let the stop loss number follows with the same margin as the stock increases in price.
Next, it would be the rule of 72. Take profit on an investment takes time and it is often hard to calculate how long it will take before the returns are substantial. To avoid the complex calculations, to find the amount of time the investment takes to double, you should use the rule of 72 to gauge the rate of return and in how many years it will take to double. An example would be to take the number 72 and divide it by the rate (e.g. 6%) at which an investment is projected to grow every year, and then divide 72 by 6 will get 12 years. Therefore, it will take 12 years to double the investment that is growing at a rate of 6%. With that in mind, the investor ought not to be affected by the stop loss or takes profit since it is going to take 12 years anyway, for amount to double for reputable companies’ stocks.
On the macro level, situations may have changed and there is a need to react to stop loss or take profit. These situations are 1) the investment thesis has changed especially when you encountered drop in dividend amount which signaled that the company is struggling financially, the entire particular industry is struggling onwards, or that a company has a negative change in its business or executive board etc., are indicators to stop loss, 2) the company that is being acquired can lead to sell to take profit or stop loss. After an acquisition is announced, the stock price of the company being acquired typically rises to a level close to the agreed-upon purchase price. Since further upside potential can be quite limited, it may be wise to take profit after the acquisition announcement, 3) rebalance of portfolio by selling due to a) owning a high-performing stock which has significantly increased in price and represented a large portion of the value of your overall portfolio and is safer to take profit to minimize risk in one company while b) seeking to reduce your stock exposure in anticipation of need for money for e.g. retirement, getting married etc., c) one popular rule of thumb for stocks investment is to subtract your age from 110 to determine the percentage of your portfolio that should be invested in stocks. If your portfolio seems too stock-heavy, then selling some stocks to take profit is advised.
Nevertheless, determining when is the most precise time to stop loss or take profit of a stock and milk the most out of it is extremely difficult. Say for example, if a stock had grown to a considerable amount and presented with the opportunity to take large profit, should you take profit now and what if the stock may fall suddenly due to attack by government or other changes in policies and profits may diminish significantly or the stock may continue grow even more. No one can really predict accurately. However, for sure, if you failed to follow the trend of the stock and recognize its dip or rise in price, you may end up missing out on huge gains and preventable losses. All investors ought to stay informed and be diligent to observe for trends, set a price target, have a benchmark for selling the stock aimed at cutting lose or realizing profits every time.
Importantly, we need to know what is stop loss and take profit.
Stop loss is set on trading stocks to remind you to pull the plug when you were wrong about the anticipated direction of the market. Stop loss enables you to exit the market when a stock has fallen below your acceptable threshold and prevent you from losing more.
Take profit is for you to decide to exit the market after realizing considerable amount of profits for the investment made and more excitingly, it is to use the profit to pay for any major purchases, living expenses, or use the profits to build and fulfill your portfolio allocation strategy by putting them into another investment to earn even more.
There is some underlying principles in stop loss and take profit for example, 1) after you had purchased a stock at a price, it will not always shoot up right away. Therefore, giving it a bit of room to move before it starts to go up is essential instead of trying to achieve zero loss. Selling immediately upon a drop will also make you lose on commission and against your initial decision of the stock’s potential growth. Have some faith, as every investor wants to buy low and sell high, hence you need to give it chance to grow. The idea of a stop loss is meant to be a safe guard only whenever you made a very wrong expectation about the stock’s direction, but not for you to make knee jerk reaction, 2) likewise, do not sell a stock for profit just because the price had risen as you will be falling into the trap of taking a small win after a stock gained in value and neglecting future greater earnings and; 3) all “buy and hold” investors have the intent to buy stocks at the absolute bottom price but may not be always accurate. If you are caught in a downtrend, the stop-loss must be executed if the price continues to decline even after the purchase.
Next, I would also categorize stop loss and take profit into two areas namely micro and macro considerations with some fundamental rules.
For micro, there is a need to determine your present financial risk appetite figuratively. For example if you buy a stock at $1.00 and set stop loss at $0.94, then you have $0.06 of risk per share. If you have a position size of 1,000 shares, the total risk on your trade is $0.06 x 1,000 shares, which is $60 plus buy-sell commission. This can correspondingly increase depending on your appetite to lose. Generally, the amount put at risk should represent only a small portion of your total trading account like 2%, meaning if $60 risk is 2%, the your trading account should be about $3000. Some trading platforms have the trailing stop-loss order function, which let the stop loss number follows with the same margin as the stock increases in price.
Next, it would be the rule of 72. Take profit on an investment takes time and it is often hard to calculate how long it will take before the returns are substantial. To avoid the complex calculations, to find the amount of time the investment takes to double, you should use the rule of 72 to gauge the rate of return and in how many years it will take to double. An example would be to take the number 72 and divide it by the rate (e.g. 6%) at which an investment is projected to grow every year, and then divide 72 by 6 will get 12 years. Therefore, it will take 12 years to double the investment that is growing at a rate of 6%. With that in mind, the investor ought not to be affected by the stop loss or takes profit since it is going to take 12 years anyway, for amount to double for reputable companies’ stocks.
On the macro level, situations may have changed and there is a need to react to stop loss or take profit. These situations are 1) the investment thesis has changed especially when you encountered drop in dividend amount which signaled that the company is struggling financially, the entire particular industry is struggling onwards, or that a company has a negative change in its business or executive board etc., are indicators to stop loss, 2) the company that is being acquired can lead to sell to take profit or stop loss. After an acquisition is announced, the stock price of the company being acquired typically rises to a level close to the agreed-upon purchase price. Since further upside potential can be quite limited, it may be wise to take profit after the acquisition announcement, 3) rebalance of portfolio by selling due to a) owning a high-performing stock which has significantly increased in price and represented a large portion of the value of your overall portfolio and is safer to take profit to minimize risk in one company while b) seeking to reduce your stock exposure in anticipation of need for money for e.g. retirement, getting married etc., c) one popular rule of thumb for stocks investment is to subtract your age from 110 to determine the percentage of your portfolio that should be invested in stocks. If your portfolio seems too stock-heavy, then selling some stocks to take profit is advised.
Nevertheless, determining when is the most precise time to stop loss or take profit of a stock and milk the most out of it is extremely difficult. Say for example, if a stock had grown to a considerable amount and presented with the opportunity to take large profit, should you take profit now and what if the stock may fall suddenly due to attack by government or other changes in policies and profits may diminish significantly or the stock may continue grow even more. No one can really predict accurately. However, for sure, if you failed to follow the trend of the stock and recognize its dip or rise in price, you may end up missing out on huge gains and preventable losses. All investors ought to stay informed and be diligent to observe for trends, set a price target, have a benchmark for selling the stock aimed at cutting lose or realizing profits every time.
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Handy_ : How can stop loss be determined to maximize their own interests
PowerhouseOP : If there are greater opportunities elsewhere we should transit there instEad of sitting in a sinking ship.
kradic34 : Thank you for sharing! I think stop loss is easier than stop profit. I often can't find a way to stop profit
PowerhouseOP : Yes. Take profit for me is often hampered by greed. Not sure about u.
Rina Ho : Agree
investorpw : Same here
PowerhouseOP : Anyone to share when to take profit? Any mantra to follow ?
WANDD88 PowerhouseOP: Thanks
Handy_ PowerhouseOP: Do you usually stop loss by trading funds or by contract time?
PowerhouseOP : Trading funds. Occasionally juSt stop first and react later. If it bounce back , weLl and good and bUy aGain. Else u can get it at lower price for same Holding.