Three Ways to Cut Losers Short and Let Winners Run

By TradeSmith Editorial Staff

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Longtime TradeSmith members know what makes our indicators special. They use the impressive collection of tools on our website to fine-tune their investment choices and, above all, to reduce risk.

But over the past year, we have added thousands of new members, who may not be as familiar with the full array of our powerful tools. And our crack team of research analysts is constantly adding new features to our TradeSmith tool kit. Plus, we are always hard at work improving the indicators that are most popular and widely used by our members.

With that in mind, I thought this would be a great opportunity to answer a question we’re often asked by members. (And by the end of this article, I’ll show you how to submit your own questions.)

“What is the difference between the various stops you display on the Stop Loss Analysis tool?”

This is, by far, the most frequently asked question by our members. And that makes perfect sense. After all, setting intelligent stops to help manage your stock positions with our flagship TradeStops tool is one of the most important features of our website.

I might go so far as to say: Stops are the most valuable investment rule you can use to help improve your results.

In fact, famed hedge fund titan Paul Tudor Jones has said: “Cut losers short and let winners run.” It is the No. 1 rule on his list. And for good reason.

Too many folks let their emotions get the better of them when it comes to their investments. That’s especially true when your investments do not go the way you want them to.

But making investment decisions based on emotion can cloud your judgment. Overconfidence, or just plain old stubbornness, can be your worst enemy.

That’s why you need to follow a sound exit strategy. And that is where our TradeStops tools come in handy.

They give you a purely objective way to cut your losers, if necessary, while letting your winners run.

Setting intelligent stops isn’t rocket science. But it is soundly based on statistics. Here’s how we approach it with our tools.

When evaluating any stock, cryptocurrency, or other investment vehicle on our website, you’ll notice that, on the position card page, the very first detail tab is for Stop Loss Analysis.

That’s how important it is.

It’s easier to use a real-world example to illustrate this powerful tool, so let’s take a look at Apple (AAPL).

Clicking on the Stop Loss Analysis, you’ll find the prices for several stop-loss strategies.

The first stop price is based on a stock’s Health Indicator status. For AAPL, it’s currently $121.66.

The Health stop price is based on the most recent high price of a stock minus the Volatility Quotient (VQ).

A stock that falls more than a “reasonable” amount from its most recent high can be a red flag, signaling potential trouble ahead. And our Health stop addresses it.

The second stop price is based on the stock’s Volatility Quotient (VQ).

It is derived by subtracting the VQ from the most recent closing price of a stock. For AAPL, the VQ stop is currently $118.

The VQ stop is based on the typical volatility of the stock you’re evaluating. And every stock is different. Some are less volatile, and some are more so.

So the VQ stop helps level the playing field, allowing you to objectively measure any stock by its volatility.

Third is the Trailing Stop, which is simply a mechanical trailing stop set a certain percentage below the current stock price.

The default is 25%. However, you can adjust this to any desired amount, either tighter (say, 10%) or looser (like 50%). Currently the 25% stop on AAPL stock is $117.61.

Here’s how these stops for AAPL are displayed on our Stock Analyzer tool.

To summarize: At the end of last week, AAPL closed in the Green Zone at $159.32. Its most recent high occurred on Nov. 24 at $161.94. The VQ of AAPL is 24.9%.

The Health Indicator Stop Loss for AAPL, based on the most recent high last week, is $121.66.

The VQ% Trailing Stop for AAPL, based on the most recent closing price, is $118.

And the static, 25% trailing stop for AAPL is $117.61.

Now, I know what you’re probably thinking. “Which stop should I use?”

Of course, there is no one-size-fits-all answer to this question. It all depends on your own personal investment strategy and tolerance for volatility.

You may be willing to take on riskier stocks, which means you should be comfortable with wider stops. On the other hand, if minimal risk is your objective, then you can set your stops closer to the current stock price.

At TradeSmith, we believe in empowering our members to decide for themselves which strategy is the best fit for their own investment or trading goals.

That’s why we created powerful algorithms to measure each stock’s typical behavior to find its personal volatility level, the VQ.

What type of exit strategy do you follow with your own investments? I’d love to hear from you. And while I can’t respond to every email, I do read them all. And I’d like to hear your thoughts on stops and exit strategies.