|  | What does it mean to set a stop-loss level at $200 to preserve capital? | | When I recommend a price such as $200 as a stop-loss level, it means that if the price of the option you purchased (perhaps you paid $400 for the put or call) falls to $200 you should sell your option to preserve capital. The use of stops is tricky, especially when there are fast market conditions. Stop orders become market orders; so don't expect to get your exact price. You don't want to limit your stop order, because you might not get filled and your stop-loss purpose is, after all, to stop your loss from getting worse by closing your position. Even though you would be closing out your position at a loss, you would not lose the entire premium; as you would if you held on till expiration and the option died worthless. Of course, there is always a chance that the option could turn around and become profitable prior to expiration; but the given stop-loss instruction is based on the observation that most-often, it pays to apply the sound money management principle of simply cutting your losses short. Speculator king Jesse Livermore once said, "A loss never bothers me after I take it. I forget it overnight. But being wrong -- not taking the loss -- that is what does damage to the pocketbook and to the soul." | | Back |
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