Stop Loss Strategies and Tactics

  1. Most people risk £100 to make £10 but at the very basic level you need to reverse this and risk £10 to make £100. For instance, buying ABC stock at £10, placing a stop loss level at £9 and a sell limit order at £10.50, so in practice risking losing £1 for every 50p gained. Personal risk management is key!
  2. In normal market conditions good traders usually stick to a 3:1 risk-reward ratio – so if you go long on a stock trading a £1, the bet would close out automatically at a 10p loss or a 30p profit. However, in volatile market conditions a more restrained profit expectation might be more appropriate such as a 2:1 ratio – so a stop of 85p and a limit of 130p. The advantage of setting stop losses close to your opening level is that you can afford to make more than just one attempt to call the market.
  3. You could place a stop loss and a limit order simultaneously, so defining the parameters within which you will make a profit or loss. But whatever you do stick with your exit strategy. Don’t let the market panic you with fear by closing out too early (that’s where limit orders come in handy as they automate the profit-taking process). Stocks tend to trend for long periods of time but even stocks that are in a solid uptrend will experience pullbacks. There’s no way of anyone knowing if a pullback will be 3%, 5% or 10% on the stock or index. Have a plan and stick to it. This is the only way to win against the big boys because this is what they do. Putting this into words on paper helps clarify what you’re doing and maintain the discipline.
  4. When setting stop loss levels, avoid even numbers – for instance instead of setting a stop at £2.50, set it at £2.51. This is because more stops are likely to be at the £2.50 psychological level and if lots of orders are triggered at the same time as the market falls your spread betting provider will execute them in strict price/time rotation.
  5. Another good idea when setting stops is to split bets on each particular share – so you get ‘tiered’ stops. If I’m staking a total of say £20 per point, I might open a £2pp bet with one level of stop, a £7pp bet with a different stop level, and a £11pp bet with another stop level — so that my bet gets reduced rather than completely closed if the move against me was a minor one.
  6. Keep your stop losses tight, but accept that in volatile markets this means a spike or dip will trigger your stop and your loss will crystallise – I’ve seen this many times and then notice that the underlying instrument move further that would have made me a killing. Also, seen it move further in the wrong direction which made me grateful for not chasing the market… You can make money even if you are correct less than half of your spread trades as long as you keep your losses small and let profits run. Some traders only get 3 or 4 out of 10 profitable trades but they still make money overall through the discipline of tight stop orders.
  7. On the other hand do not set up you stop losses way too close to the current market price. Assuming your stop is just 10 ticks, it is going to be hard to make money in the long run unless you regularly get 40 ticks of profit if/when right. Small stops are very risky, far more risky than larger stops. Do this and you will get stopped too often (death by a thousand stops…) Unless you have a good reason for placing a stop close to the current price like say a key support/resistance level it makes sense to place the stop a reasonable distance away to allow for intraday volatility. Set the stop loss below the trend line you are basing your decision to spread bet upon… Stocks unfortunately do not go up in a straight line (I wish!!) and some of the biggest wins come after a stock has fallen short term, quite often to near its 200 day MAT.
  8. Avoid putting any trades in the first 20-30 minutes after the open. It is also prudent to cancel stops or widen them during such periods so you don’t get stopped out by a wide spread on the order book. You can then always put your stops back where they should be later in the day if you’re away from your PC. Yes, it’s a pain but this has saved me countless bad entries and exits.
  9. Don’t enter the market without a proper money management strategy and do not take excess initial risks – I manage my wife’s share portfolio as well as my own and couldn’t understand at first why hers consistently outperformed mine when I often held the same stocks on both accounts. Suddenly I realised it was because I took bigger risks with mine and only bought for my partner when things were going well. In this way she missed out on some of the initial gains but more crucially, missed out on the big losses: that way her portfolio looked always better than mine. I’ve now adopted that stratagem on my own as well!!!
  10. Make sure to check your positions on a regular basis even if you have the relevant stops and limits set with each trade that you do. Remember it is your responsibility to monitor open positions.
  11. Control your Ego. There are times when you will be wrong in your trading decisions. When you’re wrong, you need to accept it – and be prepared to cut the position quickly. This is a particularly difficult skill to cultivate, as we all want to be right, all of the time. If not properly contained, your emotions could lead you to commit the classic trading mistake of running your losses too long and sometimes taking your profits too early – all because you want to validate your decision making.
  12. Review losing trades. I know it is painful and most of use don’t really want to look back but I think I think we don’t attach enough importance on understanding our losses. When we win we get excited and we don’t really learn much except that there is an element of ‘I’m a genius that’s why I got it right this time’ somewhere in the thought process. If you lose money it usually means that you have made a mistake. Made money or lost money is the only score card you have, the only thing that matters in trading. If you have lost money you want to see if you can learn from the mistake and this one reason why it is important to record and review trades. Analysing should include looking at the shares some months after you have taken the loss to see if they did what you expected and if not were there clues that you missed or ignored… If we analysed our losses we would be better traders. Even when looking at history and war – when a country analyses why it lost a battle it tends to do better next time.
  13. I used to have a system which told me every day what I was worth. Portfolio reporting system I guess. The total lead me to look at everything as capital all the time, and once I had it I didn’t want to lose it. As a result I was doing the classic mistakes of hanging onto losers too long (not wanting to admit my mistake) or selling winners too early (before they continued going down). Today, I only know where I am in total once per year when I ‘do the books’ and update all prices in my offline system. I could not tell you about “new highs” except for that once per year. On the trading front I manage each share individually against fundamentals and technical analysis, not worrying about either the overall portfolio or the individual share profit/loss situation. Yes, I have records updated for every trade which gives that individual result, but none of it is added up except for that once per year. I do use stop losses, but they are more technically based than a set percentage limit
  14. All things said keep in mind that success in financial trading means excess of gains over losses. As with all signals nothing works all the time so its an attempt to put probability in your favour. Ignore anyone who tells you that he’s always successful – I have yet to find a person, in or out of Wall Street, who is able to make money in (markets) continuously or uninterruptedly. Like all other traders, I have good and bad periods.

Here’s what Justin had to say when he e-mailed me with his take regarding stops: Time Stops is something that I do employ with particular trading strategies. Mainly when I am trading geometrics. Not so much when I’m being an “X-box” trader. ( 😛 Day trading ASX) I have noticed over the years that my best trades will start to go my way immediately. If they are slow to get moving or stagnate, more often than not the setup would fail. I defend the initial position in the first instance by halving my risk based off time when lack of price movement is evident. I will use time and price for 1st take profit target placing my position in the black. My logic – If I entered a trade it was per reason of probability of the right time and the right price. So if the trade is not performing within a predefined time (consistent guidelines) my reasons for entering that trade may very well have been incorrect. I won’t remain passive but will take action in such cases but I won’t surrender the position entirely instead I will tighten things up and the market will need to come and get me. If I’m struggling I will look for breakeven a lot more aggressively than otherwise.

I do like the idea of “scaling” in and out of positions. It gives me more control of risk and I can manipulate my exposure accordingly and do this almost entirely when I trade currency markets. I internalise the whole process as a war game and attack and defend against the stronger enemy.

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