Setting stop orders isn’t a linear process. In fact, there are many questions concerning how one should exactly place his or her stop loss order and which technique should be followed.
It is no secret that every successful trader will plan every single trade before actually taking it. This means that they will know exactly when to get out when a trade goes against them.
As such, no matter what type of investor you are, stop losses should be too be vital in your strategy because you need to control your both your risk and your losses, especially if you are planning to use leverage.
Even though there isn’t a single approach which could considered to be better than others, it is very important that investors know what options they have on the table and exactly how to use each one of them.
What is a Stop Loss
A stop loss is, in essence, a pre-determined price which an investor sets as an exit position in order to either limit his or her losses or to protect their profits. This means that a stop loss is the exit strategy in your trading plan.
As such, choosing which type of stop loss to use will depend on the overall goals you have set in your trading strategy.
The two most common errors when dealing with stop losses
The first and most common error is not having your stop placement determined before taking a trade. This is also valid for entry and target. By having these set in advance you will remove emotion from your trading decisions as no capital is yet to be on the line because you are still at the crafting stage of your plan.
Arbitrary numbers are also a known error traders make mostly due to the market not really caring about fitting your own framework or your Risk Reward Ratio . It is you, as a trader, who should adapt to the market’s conditions because those are the ones you have to play with.
Four key strategies you should know
1.Moving averages
Moving averages are a popular tool. They can be easily used to place and manage your stop loss orders.
Usually, traders will use moving average and proceed to placing the stop loss on the opposite side of the current price, meaning that a potential exit might happen once the price breaks the moving average.
It is important to consider that if there is a fast moving average, you will get in and out of trades relatively quickly. As such, a longer moving average will be much better suited for swing trading strategies as you will be able to ride trends much longer.
Adding a volatility stop loss here will greatly improve your strategy as you will understand how close, or how far, you should have set your stop loss to the
moving average, while taking in consideration the current volatility and market context.
2.Swing Points
By identifying the previous swing points on your chart, you can place you can place and manage you stop loss accordingly.
You can place them right below them which, in turn, will give you an exit once the price breaks its typical swing point.
A typical way of looking at these is by checking the previous day’s highs and lows or even the intra-day highs lows.
If you are looking at breakout or range trading, adjust these slightly and cross check them with support and resistance areas.
3.The Fibonacci levels
The Fibonacci stop loss approach offers traders an objective way of placing their stops because of how well defined they are after the Fibonacci levels are drawn.
4.Pivot points
Pivot points offer traders an even more objective strategy simply because traders don’t get to set them.
They adjust daily based on the price action, momentum, and market volatility.
This in turn means that during a stronger trending market, you will see pivot points being set further away as opposed to a low volatility one in which you will see them much closer together.
Pivot points are used much like in the Fibonacci strategy: whenever the price breaks past a certain pivot level, the stop loss is trailed right below it.
Wrapping up
The key to stop losses is arguably technical analysis but as for the right value, it solely comes down to your hopefully back tested strategy, the time frame you set, and what you feel comfortable with.
No single strategy can be considered superior to others but we consider important to get to know the different types of stop losses, their pros, their cons, and how to combine them.