Let’s examine stop losses. First, there is really no such order as a “stop loss.” We’ve called it that because stop orders are most commonly used in this protective manner, but they are still simply “stop” orders. There are three types of stop losses we will want to use at different stages of a trade. They are all going to be stop orders, but the thinking behind each stop (stop loss) order placement will be different. The initial stop we place when entering a trade is known most often as the protective stop loss. This stop loss represents the potential for loss. It’s a risk-based stop, and it’s placed where the trade would no longer be valid. The risk-based stop is the opposite of the entry. If an entry is the reason to get in, then the point of validity/risk-based stop is the reason to get out.
The risk-based stop is the one we all hope we will have the discipline to place and not have to use. Transitioning from a risk-based stop to a breakeven stop is done only when the trade moves in our favor and to the first stop loss. It should become clear right about now that using support and resistance to place stop loss and profit targets is important because a market moves from level to level seeking support and resistance. The way you place your profit target, the thinking behind their location, is what will set your risk management in motion. This is lost on far too many traders. This is how far too many traders let a winner turn into a loser. How do we define a winner? It’s a trade that has reached the first of hopefully two to four more profit targets. How do you manage two to four profit targets? That is done with multiple lots.
Once prices reach the first profit target, the trade is officially a “winner” and should be protected from a reversal that could happen when prices reach the support or resistance that was the profit target. This is a possible scenario when prices reach any kind of support or resistance, and since just about any order you place will be because of the support or resistance it has, then there is the possibility of either a continuation through this level or a reversal.
The psychological trade many traders fall into here is trailing their stop too aggressively. This is usually because they have experienced so many losers during the early part of their trading and learning curve that the slightest profit triggers a fear reaction: I have to take this profit now! Many times the traps that most of us have to navigate through can be avoided with order entry that lets us observe the market rather than being involved with it too hands on once the trade goes live. There is too much temptation, fear, and greed, and the only way we can avoid and manage these emotions is with order entry.
First of all, the only way a trade should and can be extended past the first profit target is to have multiple lots. One lot equals one profit target. A breakeven stop allows for enough wiggles (the typical amount of volatility) that a position must be given in order to compensate for corrections along the way to the next profit target. Trailing stops are most often and incorrectly done by using some sort of fixed pip or percentage. I’ve already explained why stop losses should not be placed with this type of thinking, and the same thing applies to every kind of stop. Trailing a stop is done as a trade moves in the direction we expected it to and reaches profit targets, which then in turn trigger the transition from risk-based to breakeven to finally trailing stop.
A breakeven stop, as the name implies, is where the trade would be stopped out and yield no loss or gain. It’s placed either just below the entry price if the entry is a buy or just above the entry price in a short. The breakeven should be just beyond the entry as to be able to get maximum use out of the support or resistance that triggered the entry. As a trade progresses, if it progresses, the trailing stop is next.
Trailing stops are what we all love because they mean that no matter what, the exit is still a profitable one. But they should not be placed with fixed levels that trail current prices. The same levels that were once profit targets are now going to be valuable levels of support and resistance that the trailing stops will be placed at. Here’s how it works. On the chart there are multiple levels that the trade could travel to as it moves in the profitable direction and these levels are resistance in a buy and support in a short. Remember that what was once support becomes resistance and vice versa, so that now we are looking at a set of levels that can support prices in an uptrend and be a ceiling in a downtrend. This is exactly what we need for trailing stops.
The stop order itself should not be placed at the profit target level exactly but just beyond. So that means that in a buy, the resistance levels that were once profit targets are now support and trailing stop levels. Place the stop order just below the support level. In a short it’s the support of profit targets that have become resistance so the stop order will be placed just above that level. How much above? Three to five pips to account for the spread will do.
The risk-based stop is the one we all hope we will have the discipline to place and not have to use. Transitioning from a risk-based stop to a breakeven stop is done only when the trade moves in our favor and to the first stop loss. It should become clear right about now that using support and resistance to place stop loss and profit targets is important because a market moves from level to level seeking support and resistance. The way you place your profit target, the thinking behind their location, is what will set your risk management in motion. This is lost on far too many traders. This is how far too many traders let a winner turn into a loser. How do we define a winner? It’s a trade that has reached the first of hopefully two to four more profit targets. How do you manage two to four profit targets? That is done with multiple lots.
Once prices reach the first profit target, the trade is officially a “winner” and should be protected from a reversal that could happen when prices reach the support or resistance that was the profit target. This is a possible scenario when prices reach any kind of support or resistance, and since just about any order you place will be because of the support or resistance it has, then there is the possibility of either a continuation through this level or a reversal.
The psychological trade many traders fall into here is trailing their stop too aggressively. This is usually because they have experienced so many losers during the early part of their trading and learning curve that the slightest profit triggers a fear reaction: I have to take this profit now! Many times the traps that most of us have to navigate through can be avoided with order entry that lets us observe the market rather than being involved with it too hands on once the trade goes live. There is too much temptation, fear, and greed, and the only way we can avoid and manage these emotions is with order entry.
First of all, the only way a trade should and can be extended past the first profit target is to have multiple lots. One lot equals one profit target. A breakeven stop allows for enough wiggles (the typical amount of volatility) that a position must be given in order to compensate for corrections along the way to the next profit target. Trailing stops are most often and incorrectly done by using some sort of fixed pip or percentage. I’ve already explained why stop losses should not be placed with this type of thinking, and the same thing applies to every kind of stop. Trailing a stop is done as a trade moves in the direction we expected it to and reaches profit targets, which then in turn trigger the transition from risk-based to breakeven to finally trailing stop.
A breakeven stop, as the name implies, is where the trade would be stopped out and yield no loss or gain. It’s placed either just below the entry price if the entry is a buy or just above the entry price in a short. The breakeven should be just beyond the entry as to be able to get maximum use out of the support or resistance that triggered the entry. As a trade progresses, if it progresses, the trailing stop is next.
Trailing stops are what we all love because they mean that no matter what, the exit is still a profitable one. But they should not be placed with fixed levels that trail current prices. The same levels that were once profit targets are now going to be valuable levels of support and resistance that the trailing stops will be placed at. Here’s how it works. On the chart there are multiple levels that the trade could travel to as it moves in the profitable direction and these levels are resistance in a buy and support in a short. Remember that what was once support becomes resistance and vice versa, so that now we are looking at a set of levels that can support prices in an uptrend and be a ceiling in a downtrend. This is exactly what we need for trailing stops.
The stop order itself should not be placed at the profit target level exactly but just beyond. So that means that in a buy, the resistance levels that were once profit targets are now support and trailing stop levels. Place the stop order just below the support level. In a short it’s the support of profit targets that have become resistance so the stop order will be placed just above that level. How much above? Three to five pips to account for the spread will do.
