Stop losses can take you out of positions you don’t want to be in and save you from big losses…
But they can also take you out of positions, then the stock can quickly rebound and your trade idea can end up working.
So how do you balance the two possibilities?
Should you stop using stop losses and wait and see what happens?
Or should you keep using them and deal with sometimes unnecessary losses and frustration?
There just might be an alternative method you can use to find a solution between these two scenarios…
First, you have to understand volatility, and my rule of five — I’ll break them down for you today.
This is a topic I covered in my Facebook live session this week — join here so you can get in the next one and have your questions answered!
Volatility, Stop Losses, And My Rule of Five
The penny stocks we trade are extremely volatile. That’s why we love them — because they can have big upside moves that can help you grow a small account.
But the volatility can be a double-edged sword if a stock has a big downward move.
There’s always a risk that a stock will spike, you’ll enter, then it will reverse and you have to cut a loss.
You could have two out of three trades work for you, and you could still blow up if you don’t cut your losses the one time your setup doesn’t work…
But then you can get a stock like Baudax Bio, Inc. (NASDAQ: BXRX) on Tuesday…
It was a low-float biotech with news that checked a lot of the boxes and it just didn’t work.
If you don’t use a stop loss that one time — your account is basically gone.
So the best way to handle volatility is to use stop losses. But it only works if you keep your losses small.
It comes down to making the right trade plans and having the right risk to reward.
That’s where my rule of five comes in…
The Rule of Five
Let’s say you trade once a day, five days a week (which I think is enough for any new trader)…
And on a bad week let’s say you lose $100 on Monday, $100 on Tuesday, Wednesday you lose $100, and Thursday you lose $100…
You’re in complete despair and ready to quit. And I wouldn’t blame you…
Losses are annoying and frustrating. But in this scenario, you contained losses.
If you have a small account of around $3,000, now you’re down $400 in a week. That’s not the end of the world — you’re still in the game…
Then on Friday, you can get a beautiful setup like MGRX…
So my plan had roughly $1 per share of upside with 20 cents of risk — that’s five to one risk to reward.
MGRX hit a high of $3.18.
So, you had plenty of time to get out with profits following the plan.
And in this scenario, you made $500 on Friday. You made back all your losses and you’re green for the week.
I know you don’t want to make $100 per week … But here’s where the rule of five hits home…
This scenario only works if you take small losses the rest of the week.
It doesn’t work if you take a $500 loss, then a $200 loss, then a $150 loss, and a $300 loss.
It only works if you keep losses small, and keep trading the right stocks and setups.
Then it only takes one good trade to make your week and help you grow your account over time.
So while stop losses are frustrating when you take a loss and a stock does what you think — keeping your losses small and sticking to your risk is crucial to growing your account.
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Have a great day everyone. See you back here tomorrow.
Lead Trainer, StocksToTrade