Stop-loss
Stop-loss
What is a stop-loss? In technical financial terms, it is 'denoting or relating to an order to sell a security or commodity at a specified price in order to limit a loss'.
A practical example: Facebook ('Meta') crashed after its earnings report were considered a disappointment by the market, their number of active users declining for the first time in its existence. Probably not nothing.
Price moved down from circa $330 to $230. Let's say you think this has now become a potentially interesting trade setup and buy some stock at these prices. Your entry price is $240. A trade could for example be: Target $300 on a bounce, stop-loss below $220 because, well, that means there is no bounce. Below $220 you get out again for a small loss. Risk $20 per stock for a $60 potential gain. Needs to be right 25% of the time to be profitable. The main thing you are accomplishing by using a stop-loss here is that you are safe from needlessly big losses in the event that you are wrong. Whatever the reason may be, buyers are not interested, prices fall lower, and the bounce you had bet on never materializes, as price keeps trending down. A stop-loss can be set to trigger automatically or manually.
Note that the success factor or potential edge in this trade doesn't depend on 'being right' but on asymmetry and risk management. Often, you will lose the $20. That's the cost of doing business, when attempting to win $60.
Every trade, or plan, by definition, will fall in one of 4 categories:
Small loss, small win, big loss, big win. The only one that should (and can) be avoided are big losses (whether it be denominated in time, money, energy...). The only way to do that is by cutting them while they are still small. This is why when people ask me if something is a good investment or even just a good strategy or a good idea, more often than not, the answer is ‘it depends on your stop-loss’.
On the flip-side, the only way to obtain big winners is by letting them run and not being content with small wins. Probably much harder than keeping losses small, because cutting a loss takes a split second but letting a winner run takes theoretically infinite time and delaying gratification. I’m sure some people are reading this and are like ‘damn, that’s so true...’. I feel it too, friends.
Disclaimer. First of all, I didn't take this trade and more importantly, for the avoidance of doubt, again borrowing from the one and only Cobie on Substack and Twitter: 'None of this financial advice. I’m not a professional and mostly am stumbling my way through the world the same way I was at age 13. I, like everyone else, am simply an aged baby walking blindfolded into a forest, startled by my own humanity.' :)
Another way to view having a stop-loss is like having an invalidation.
Let's say the sun is shining brightly and you decide to go to the beach. Then it starts to rain.
Based on this new information, your original thesis (it's hot so going to the beach today will be fun) gets invalidated. As the raindrops keep falling on your head, you decide to return to your home. Your stop-loss is triggered, so you leave the beach. You essentially re-calibrate your plans based on this newfound information.
You don't judge the rain. You don't sulk about making a ‘bad’ decision when you initially decided to go to the beach. You also don’t stubbornly keep sitting in the rain. You re-align yourself with reality in order to reevaluate further decision making. There will be other opportunities in the future. And so it should be in trading as well. Don’t hold assets in downtrends. There are countless trading systems and styles in the world, but whether they revolve around trend following, swing trading, day trading or scalping, the only common denominator they all share is that they agree on the need to avoid big losses, so that whatever happens, one can stay in the game, staying alive to fight another day. Being wrong is OK, staying wrong isn’t.
Where you place the stop-loss, how often you move it, where you move it to, which balance to keep between avoiding losses and securing wins..trade, idea, project and relationship management are arts and not an exact sciences, but the important thing is to have one. Don't let the perfect be the enemy of the good. Just make sure you have one. Why am I going on about the importance of stop-losses and invalidations?
Because I want to throw some takes around about NFTs in the coming posts and every take should have an invalidation, both the ones for or against NFTs. Tangent over. I’m going to be bringing up stop-losses a lot. For example, ‘I think NFTs are a fad’ —> Where is your invalidation on that hot take?
For good measure, let's define NFTs so we can build on that later. Most articles I read in legacy media already over-complicate the easy part and, well, I will try to do better.
NFT is an acronym for non-fungible token, which essentially means an asset that’s unique, rather than an asset that’s identical to many other assets.
An example of a fungible token, for instance, is like a US dollar. Every US dollar is meant to be identical to every other US dollar, and can be used interchangeably and all of them represent the same amount of value. Fungibility is one of our modern currencies’ greatest features.
An example of something that’s non-fungible, on the other hand, is say, a piece of artwork, like the Mona Lisa, or your pet. There are many paintings in the world, but there is only one Mona Lisa, and you can’t just replace the Mona Lisa with some other random painting and call it the same thing. Same with your pet — plenty of cats and dogs out there, but you’d probably be pretty upset if someone just decided to swap your dog with a random other dog one day.
In essence, an NFT is just a digital representation of this intrinsic concept of non-fungibility, or uniqueness, that we’re already intimately familiar with in the physical world. Houses are non-fungible, people are non-fungible, signed contracts are non-fungible, and so on. NFTs could have been called Unique Digital Possessions (UDP©) and it would have been better branding because it would have been a better conversation starter. Why do we need UDPs, I mean NFTs? Well, because not having them is the reason the current default is that nearly everything on the internet ‘belongs’ to a handful of newly created Big Tech oligarchs. Succinct argumentation, no?
In 20 years, we will look back on the beginning of the internet era and our children will ask “What? All of your data ‘belonged’ to someone else, to a few companies? That doesn’t make any sense, that’s crazy. You could only own domain names? Everything else was someone else’s ‘property’ and you waited 30 years to invent a way that people could network online whilst still being able to keep their data possessions? No way, lmao.”
I didn’t want to make it way too long in one go after the stop-loss tangent, so later this week I will continue and elaborate on the importance of digital scarcity and property, the skepticism about NFTs, their role in art and music, and what I think the real killer apps will be.
