Is the stop loss order easy to use when trading ETF?

When trading exchange-traded funds (ETF), whether a stop loss order is a good idea seems to be a simple question, so what you are about to read may seem unorthodox. But if profit is your goal, then you may want to consider the following information.

Key points

  • Stop loss orders usually force traders to exit the ETF and lock in losses at the worst.
  • Professional traders usually combine technical analysis and fundamental research to make decisions instead of relying on stop-loss orders.
  • Stop-loss orders can reduce the loss of individual stocks, but even here there are restrictions.

ETF stop loss equals big risk

This equation may seem a bit backwards at first glance. Suppose you use a stop-loss market order on an ETF, and the ETF temporarily trades at a steep discount to its net asset value (NAV). What will happen? When the ETF offers a discount, your position will be sold. You can use stop-loss limit orders. This way, your sales will not be triggered at the bottom. However, this is still not a good deal. You can also try to implement an arbitrage strategy, but it is complicated and requires liquidity, speed and sufficient funds. You can also try other order types, but they may not help.

Most ETFs track indexes. Let’s take the SPDR Standard & Poor’s Retail ETF (XRT) as an example. If XRT plummets by more than 10% in a day, then you know that something may be wrong. Regardless of economic and market conditions, it is unreasonable for all stocks in the S&P Retail Select Industry Index to fall by 10% or more at the same time. Therefore, if this happens, it is most likely due to errors in the bearish and insufficiently liquid environment. This means that XRT may soon rise to its actual value. This is where you want to increase your position rather than sell. Unfortunately, if you use a stop loss, then you have no choice but to sell. During the flash crash on May 6, 2010, many people were locked in losses by such stop-loss orders.

Amateur and professional

If you have any connection with the stock market, then you may have encountered various traders. However, we can narrow it down to two types: amateur and professional. The amateur trader will run multiple screens at the same time, and the voice of the TV expert will sound in the background. The businessman’s feet will rest on the mahogany desk, smoking a cigar, while looking at you with a superior look. That’s the kind of businessman who wears a suit while working from home and buys luxury cars on credit.

Professional traders are more secretive of wealth. These investors trade with discipline and conviction, without emotion. Professionals may apply technical analysis, but know that in-depth research on fundamentals is also necessary. It is impossible to generate real confidence in the position using only technical analysis. Self-discipline and the ability to manage risk through statistical analysis are the main characteristics of successful traders.

Calm and rational people who are good at numbers are usually the best traders.

According to research, professional traders who see that the trading price of ETFs are much lower than they should be will not despair and sell prematurely. On the contrary, professionals will gradually buy more stocks. When you have true beliefs, you will not be afraid when you buy more ETF stocks at predetermined intervals. Excluding leveraged ETFs and inverse ETFs, ETFs tracking index will not reach $0. Therefore, the occurrence of rebound is often only a matter of time. Of course, you must grasp the trend, unless you want to wait a long time. Traders need to understand fundamentals and technical analysis to determine trends. When both are bullish, your trend is right.

In addition, regarding dollar cost averaging, you may want to consider never increasing positions below the minimum buying point. This may limit the upside potential to a certain extent, but it will retain capital. In addition, a capital allocation limit is set for each ETF. In addition, diversify long and short positions so that you can make money no matter where the market goes. If you are bullish on the highest quality and bearish on the lowest quality, it is only a matter of time before profits start to roll in.

Stop loss for individual stocks equals risk reduction

Stop-loss orders are indeed valuable, but they only apply to individual stocks. Unlike most ETFs, individual stocks may fall to $0, so stop loss can help you stay out of trouble. Of course, if you are a professional, you will not let greed blind your eyes. Professional traders try their best to avoid owning anything that might actually go bankrupt. Even with the most complete plans and seemingly respected companies, such as Lehman Brothers, things can sometimes go wrong.

Suppose you initially believe that the retailer will turn losses into profits and buy shares in that stock. It turns out that the company missed the top and bottom lines, while reducing guidance for the current fiscal year. It also assumed more debt to help fund existing businesses. It was definitely a disaster. There is no good news here, the risk/reward is terrible. Professional traders will admit failure and move on. Due to the possibility of gaps, there is no guarantee that the stop loss will produce the effect you want. It is still strongly recommended that you use one in speculative stock purchases.

Bottom line

When it comes to stop-loss orders, your approach should depend on whether you are trading ETFs or individual stocks. For a typical ETF, if the trend is correct, a short-term plunge is definitely the worst time to set a stop loss. Rather, this is where you want to strengthen and buy more.

Because there is no diversification, the risk of individual stocks is much higher than that of ETFs. In this case, stop loss should be strongly considered, especially if it is a speculative behavior.

Finally, don’t over-trading. In order to control emotions, limit transaction fees, avoid day trading, and stick to trend trading. Don’t go to the game. Let the game come to you.

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