One of Sun Tzu’s most famous quotes is: “Every battle is won before it is fought.” The phrase implies that it is planning and strategy that wins wars and not the battles themselves. Similarly, successful traders commonly quote the phrase: “Plan the trade and trade the plan.” Just like in war, planning ahead can often mean the difference between success and failure.
Stop-loss (S/L) and take-profit (T/P) points represent two key ways in which traders can plan ahead when trading. Successful traders know what price they are willing to pay and at what price they are willing to sell, and they measure the resulting returns against the probability of the stock hitting their goals. If the adjusted return is high enough, then they execute the trade.
Conversely, unsuccessful traders often enter a trade without having any idea of at what points they will sell at a profit or a loss. Like gamblers on a lucky or unlucky streak, emotions begin to take over and dictate their trades. Losses often provoke people to hold on and hope to make their money back, while profits often entice traders to imprudently hold on for even more gains.
Take-Profit Points, trading greed, trading fear, trading emotions, financial behavior
A stop-loss point is the price at which a trader will sell a stock and take a loss on the trade. Often times, this happens when a trade does not pan out the way a trader hoped. The points are designed to prevent the “it will come back” mentality and limit losses before they escalate. For example, if a stock breaks below a key support level, traders often sell as soon as possible.
On the other side of the table, a take-profit point is the price at which a trader will sell a stock and take a profit on the trade. Often times, this is when there is limited additional upside given the risks. For example, if a stock is approaching a key resistance level after a large move upwards, traders may want to sell before a period of consolidation takes place. (more…)
