When you create a trading rule book, the idea of stop loss forms a very important constituent. A seasoned trader in any market never ventures without a stop loss. Stop loss is a must, whether you are a trader or an investor; whether your view is long term or short term. Stop loss is the level or situation when it makes more economic sense for you to exit the trade, rather than to stay on.

But why is a stop loss so important? Investing is never a one-way street. The best of traders, probably, get 60% of their trades right. What makes them successful is that they exit losing trades quickly and hold on to their winning trades long enough. A stop loss frees up your liquidity, protects your capital in volatile markets and ensures that you live to fight another day.

Stop loss also has a psychological underpinning. Let me illustrate. Most traders get into a trade with the assumption that their view is right. It becomes difficult for them to admit that the view was wrong and hence they tend to hold on to positions. A stop loss builds in an automatic discipline into a trade. Thus you are rarely illiquid when the next opportunity arises.