Where do you Place the Stop Loss?

Q. Where do you place the stop loss?


A: This is one of the most common questions and numerous articles have been written on stop-losses. I've even tried to address the issue of where to place a stop loss myself here. In practice, I think it depends on what you're trading and your trading style. If you're momentum trading tight stops would work well. For longer trending trades on less volatile stocks I think a wider stop is preferable so that you can let the trade breath through its longer term channel. I'm very discretionary with my stops but generally I'm looking at 40-50 ema or 5xatr or the previous significant low. On the other hand I am happy to bank some profits at around 2xatr. But to get a different perspective, Rakesh a full-time trader tries to address the issue of stop losses below -:

The way you manage your stop-losses will depend on your trading strategy. Setting stop-losses is a complex business, and a key skill that can only be acquired through practice. Traders frequently overlook it - to their cost. Choosing a suitable stop-loss level will depend on three factors: (i) the time horizon of the trading strategy; (ii) the instrument's natural volatility; and (iii) the general market conditions, including trading volumes and the newsflow surrounding the instrument in play.

The most popular strategy is to identify major support and resistance points and place a stop-loss just beyond these points. Which support and resistance levels you select will depend on your time frame. Less convincing ways to set stop-losses include fixed-price stop-losses at a set percentage away from the current price, or using an arbitrary stop-loss a set number of points away from a price that is calculated by estimating how much you are willing to lose.

Identifying support and resistance levels should be a fairly straightforward task with a decent charting package and reliable price data. The more times a price has come off a certain level, and the longer the time period involved, the more significant the level. Round numbers and landmark figures often prove significant, such as 7000. But placing a stop-loss at a round number is to be avoided, just as you wouldn't put a stop-loss exactly at a support or resistance level.

Remember, though: the only time you should ever move a stop-loss is to protect a profitable position. If you get your trade wrong, then throw the towel in, reflect on what happened and move onto your next trade. Allow your personality to tell you how much of a loss you can take before you start making emotional decisions. So only take trades where the stop-losses will allow you to stay within your comfort zone.

Another way to make sure that your stops are a sensible distance away from your entry level is to check the average true range. A possible arrangement is to use 3 times the 10 day average true range (ATR) for long term trades, 1.5 ATR for trades lasting 5 - 10 days, 1.0 ATR for trades lasting 1-3 days, and 0.25 ATR for intraday trades. The nice thing about ATR is that it goes up when volatility increases so it gets the trader to use wider stops when the market volatility increases.

Also, look at the daily range high-to-low on the instrument, and factor this into your stop-loss placement. Observe similar instruments or related markets to see if there are any clues as to where support and resistance points lie, and look for major chart patterns. Most importantly, though, try to define the general market conditions for the instrument you are trading. Identify if they are bullish, bearish or sideways, and place your stop-losses accordingly.

Note: A common mistake made by spread traders is to set their stops too close to where the market is presently trading. This not only puts your trades at risk from sudden market spikes and market volatility (especially at the opening and closing phases of the markets) but also from yawning spreads that could knock out the stop.

Q. I was wondering where you set your stop losses. I've been setting mine 10% below for the trigger point...

A: Hello and good luck with your trading. Firstly you're definitely on the right track if you commit to a stop loss on each position that you take.

Where you set your stop can be as complicated or as simple as you want. I guess there's nothing wrong with 10% as a rule of thumb but I think that's only part of the equation. Allied to that is the size of your stake and potential impact on your capital. Personally, I like to find a reason where my stop might have a little bit more protection, like trying to slot it behind some kind of support or resistance, you could use fibonacci or trendlines or just a simple look on the chart to see where 'bunching' has occurred - if a breakout get in behind the breakout candle, these positions should still be within a % or 2 of your stop, otherwise the risk increase is not worth it. This method gives you that little extra chance during the cyclicity of an instruments travels of coming out on top - how many times do you end up getting stopped stopped and then the price continues back on its original trend, remembering that things on the market travels in cycles really helps to understand how to ride out the fluctuations and not take profits or losses too early Patience is needed - we all like rocket stocks but sometimes they need to orbit a few times before blasting through the atmosphere, and in the case where the trend is changing then your stop gets you out without too much damage!

However, I'm afraid placing stops is one of those down to experience things. There are too many variables to use just one standard setting. Things like how twitchy aand volatile the markets are at the time, the companies size by market capitalisation, the % spread of the shares price, your particular trading strategy and how long you intend to hold the trade i.e. are you setting a fixed target or going to trail stop a trend. It might also depend on how far back the previous price pullback was. One idea is to to look and see what the shares spread is at the market open. If its 3% then add that to your 10%. If its 8% then you might want to consider adding that. Again it comes back to only trading larger capitalised liquid companies with tight spreads as they give you less risk of a big percentage loss on any one trade. The name of the game is lots of small profits and NO big losses. Whatever you do always base stops on risk taken and then relate in some shape or form to the value of your portfolio.

Q. But how do you decide the stop loss value on a share?

A: As I have already stated if you open a margin position at a particular price, you should protect yourself against the risk of making a substantial loss by selecting a price level where you will exit the position, thus limiting any losses. Where to place the stop loss level is I'm afraid a huge subject of its own and there's no right answer. Some use resistance on charts, some use previous lows/highs, some simply say 20%, some use a multiple of the average true range, some will use the stochastics, RSI, MACD, CCI, a cross of a moving average...etc. All stops should however be linked to a trader money management approach and risking no more than 20 per cent of an initial margin amount on a spreadbet trade is prudent. Some traders even mix short-term and long-term positions on the same stock. On the longer term ones an idea would be to tier the stops. Say, splitting the bet into three with differing stops on each tranche, so that a position will automatically reduce in certain market conditions rather than fully close. It is, however, as I said a huge topic but basically you have to find something that works for the timeframe you are buying for and for the stock itself.

For instance, the Abcam chart above has three stop strategies that you could use. Assume I am long trading only. You could buy and close on the moving average pairs crossing over. In this case I have 5 EMA and 8 EMA. The second option is to follow a CCI zero line cross. Here I have 60 period open the trade on a zero line cross upwards and close out on zero cross downwards. The third option is what they call price action, which is trading the individual bars. You open a trade when a bar closes end of day above the closing price of the previous two bars. You close the trade when the a bar ends the day lower than the closing price of the previous two bars. There are many other stop strategies but no one strategy is the best all the time.

Also, no one stop system will fit all markets so it will depend upon your time frame and how the market is behaving. If you want to hold for the longer term you will need a different stop strategy than if you are swing trading for shorter moves.

Until you can plan a trade with a target and a stop, be very careful. Use something like 10% price fall.

For example...

275 in.

10% fall = 247.5 out...

Suppose you don't want to lose more than £500.



Buy 1818 shares...around...1800.

Obviously I am doing this without costs...you need to include costs. What should be clear to you is that the better you are at picking a tight stop, the more shares you will buy and the more money you will make. You also need to take into account volatility in the market and to plan accordingly.

 ...Continues here - Avoiding Moving Stops Orders Once Set

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