The stock market is an instrument filled with number of variables. The stock prices are driven solely by demand and supply. The more the demand the higher the prices will go. The more the supply the lower the prices will come down.
The experts try to understand these variables in their limited capacity and are broadly classified into fundamental and technical analysts. The fundamental analysts try to understand the fundamentals of price and try to deduce their conclusions based on external and internal factors. The technical analysts believe that the variables are factored in the price and reflect on the charts. Whereas fundamental analysis helps one to choose the right instrument with a high probability of success, technical analysis helps one to time the markets with the best probable entries and exits.
The one factor that is common with both these thoughts is the probability. Probabilities lead to assumptions and these assumptions lead to uncertainties.
A trader thus identifies a trade on the basis of certain assumptions which he thinks would result in a probable outcome and is uncertain of the same till it is achieved. Based on these assumptions, he enters a trade. He looks at his charts assuming that the next candle or bar would move in his desired direction. He could probably be right. He could probably be wrong.
He could be right and would let his profits run and subsequently earn a huge profit. But there is also an equal chance that he would be proved wrong and subsequently, his trade would result in a huge loss.
He takes the trade on an assumption and is not sure if he will achieve his target price. He could achieve his target price or the price could move beyond his target price or stop short just before it hits the target. In other words, he has no control over the amount of profit he will earn. He has no control over his trade and subsequent profits.
The converse, however, can be controlled and is probably the only factor that can be controlled once a trade is taken. If the price does not move in the desired direction, a trader can decide the amount of loss he is willing to absorb depending upon his risk appetite. He can choose to exit an undesirable trade at will.
Trade-in progress is the toughest time for a trader because he has to make spot decisions. Emotions set in. He is gripped by greed and fear successively. And there is always this huge monster of natural disaster, international unrest and political instability looming in the background, willing to tank the markets at any given opportunity.
A trader is thus prudent who protect his capital from these uncertainties by deciding a pre-determined level where he would exit his trade with a small loss in order to prevent a big one.