The Free Brokerage Tool That Could Make You A Trading Legend
If you’ve been to one of my live trading classes, you have heard me talk about trades with “good” risk/reward — in other words, trades where we are risking less to make more.
If you manage your risk/reward profile the right way, you don’t even have to be that good at picking stocks.
For example, if you lose an average of $0.50 a share when you lose on a trade, and gain an average of $5 a share when you win…
You can lose on 10 trades and win on one and break even. Heck, if you lose on eight trades and win on one, you’re doing OK. And if you only win one out of every five, you are going to end up as a “trading legend.”
Not because you’re an amazing stock picker, but because you’re so good at managing your risk/reward profile!
On the other hand, if you make an average of $0.50 on a winning trade and lose an average of $5 on a losing trade… then it doesn’t matter how great you are at picking stocks — you are going to end up losing money on your overall trading activity.
Without good risk/reward management, you might as well set your cash on fire now and save yourself the time.
You just can’t outrun it. That’s why it’s important to have it working for you… not against you.
One of the best ways to do this is to cut your losers early and let your winners run. And there’s a free tool every trader has access to that makes this process as easy as clicking a few extra buttons on your brokerage platform when you’re setting up your next trade…
The Important Trading Tool For Maintaining A Good Risk/Reward Ratio
A stop-loss order is a type of order you can place with your broker to buy or sell a security (like a stock or option) when it reaches a certain price. When the security hits your designated price, the stop-loss order turns into a market order and executes at the next tradable price.
For example, let’s say you purchase a call option for $1. You want to keep your losses small, so you set up a stop-loss order at $0.50.
If your trade works out and the option’s price moves higher or just stays above $0.50, nothing will happen; you’ll stay in your trade until you choose to exit. But if your call option drops to $0.49, your stop-loss order will execute and sell your option before the loss gets too deep.
When you use a stop-loss order, you’re doing exactly as the name suggests — you’re stopping further loss to your position’s value.
As many investors have seen over the past few months, stocks can be chugging along, seemingly unstoppable, to careening off a cliff in a moment’s notice. It just takes one remark from a Fed governor… or a tweet from a foreign official on some geopolitical development… or a few words from the president…
Stocks can easily go from a rally to a selloff in a market like this. Trading without a proper stop-loss in place is like walking a tightrope without a safety net.
By setting a stop-loss, we take back control over our trades.
If our trade starts to fall, we are able to get out at a price we have already determined. This protects us from further losses should the trade continue to decline. And that’s key to maintaining a good risk/reward profile.
Using Stop-Loss Orders To Become A Risk/Reward Legend
Now, I’m well aware that many people reading this are very familiar with stop-losses. But crazy as it sounds, there’s a large number of traders that still do not use them.
Remember… you don’t have to win every trade to be a successful trader. But you do have to keep your losses small. As I’ve shown here, using stop-loss orders makes that easy.
But stop-losses don’t just apply to losing trades. We can use this same concept to protect our profits on a winning trade.
I’ll show you exactly what I’m talking about using a real trade we just closed in The Profit Machine.
During my live trading class on February 8, I recommended buying a call option on Discover Financial Services (DFS) for about $0.70. By the next day, our calls were already trading up above $1.50 — a gain of more than 100% in just 24 hours.
Most people would have snapped up that 100% profit without a second thought. But because I took the time to analyze the trade and make a plan before opening the position, I knew the trade had the potential to go higher. In fact, my price target for the calls was $2.10, which would give us a 200% profit on our trade.
I wanted to let my winner run… but I also wanted to protect the gain we had on the table. So here’s what I did next…
On February 9, I sent a trade alert to The Profit Machine, telling members to:
1) Set a sell limit for $2.10, my 200% profit target for the calls.
2) Set a stop-loss order for $1.50, which would protect our 100% gain.
This setup locked in a minimum of a 100% gain while leaving the door open to hit the 200% target. In the end, our calls wound up hitting my $2.10 target the next day, giving us that 200% profit I believed we could achieve. But it was a weight off my shoulders knowing that we’d still walk away with double our money even in the worst-case scenario.
See what I mean about taking back control over our trades?
Not every trade is going to go your way — losses happen to the best of us. But how you handle your risk/reward management is what will set you apart from the average trader.
So let this serve as your reminder.
Protect your profits and cut your losers…
Set a stop-loss order.
And be sure to join us every Tuesday at 9 a.m. Eastern for LIVE trading with The Profit Machine for more tips and trade recommendations just like this!