The Traders Secret Art of Setting Stop Losses

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Written by Administrator
Tuesday, 19 September 2006
The Traders Secret Art of Setting Stop Losses - Guaranteed To Boost Profits, by David Jenyns When traders first begin considering their stop losses, keep in mind this comment from Tom Baldwin, a leading day-trader. He said, "The best traders have no ego." Successful traders are faced with losses constantly, and they swallow their pride and get out of the position when they have to. This allows traders to survive in the market long enough to be successful. Traders set their stop losses, and then stick to the plan. How do traders go about setting stop losses? There are several different ways. Traders could base a stop loss on a percentage retracement, where the allowed share prices retrace a certain percentage of the entry price before the exit. Different indicators can be used to identify where the stop loss is going to be set. Traders could also use support and resistance stops to set the level at which exit is made. The key is to simply have a stop loss in place. Personally, I find these options too subjective. I prefer having a mechanical way to calculate my stop losses, so I use a volatility based stop. The reason I use this type of stop is because volatility generally represents a measurement of how quickly the stock either rises or falls (market noise). Consequently, if I measure the stocks volatility, and take a multiple of that value, I'm probably going to have set my stop loss beyond the immediate noise of the market. This ensures I am not stopped out of a position too often. Traders can measure volatility by using the Average True Range (ATR) of a stock. This value can be found with most charting packages. Basically, the Average True Range (ATR) indicates how much a stock will move on average over a certain period. For example, if traders had a one dollar stock that moved up five cents on average over the last 20 days, that doesn't tell traders whether the stock is moving up or down. It just tells traders on average how much the particular stock moves. The average true range is a great tool and that can be utilized in the traders trading plan for more than setting stops. If traders are not familiar with setting stops, I recommend traders to do research. One place for excellent article sources is at the System Trading Blog . Traders use indicators in calculating the stop loss by subtracting a multiple of the Average True Range (ATR) from the entry price. For instance, I could take two times the ATR and subtract it from my entry price. If we look at the example, I just touched on, with a one dollar stock, an ATR value of five cents and a multiple of two the amount is ten cents. Which, subtracted from our entry price of one dollar gives a stop loss value of 90 cents. Before traders even enter a position, they should know where the selling point of the stock should be. If the share price doesn't move in the traders favoured direction, but moves against them, traders will know when to sell. Emotions are removed from the equation, and they simply follow what the stop loss dictates. This is how most successful traders limit their losses. They know when they're going to sell before they begin trading. Although their methods of calculating this stop loss may vary, all traders have a stop loss in place. The stop loss is a crucial part of the traders trading system. Without it, even the best designed trading system can't deliver profits. About the Author Discover the "secret formula" of trading that anyone can use to consistently generate BIG profits. http://www.ultimate-trading-systems.com/stocks.htm Trackback(0) TrackBack URI for this entry Comments (3) ... written by mmghani , September 22, 2006 It is a very pertinent point that has to be noted in trading to avoid sleepless night. Best is to discuss a few stop loss indicator and their pros and cons. ... written by maxforce , October 15, 2006 Common practice of stop loss strategy would probably include the following, though not withstanding: 1) Percentage of price movement. This is associated to the risk appetite by the investor. 2) Patterns validity. Assuming the trade was entered into with a certain validity of a pattern, then logically the stop loss should be when the price movements violates the pattern. 3) Indicator movement. Assuming the trade was entered due to certain indicators, then when the indicator reverses, stop loss should be triggered. This is to avoid bear and bull traps. 4) Fundamental reasons. Assuming the trade was entered as a value buy considering the fundamentals are still intact, then when there is a change is fundamentals, stop loss must be adhered to. Otherwise, the stock would be worthless in no time. IMO, stop loss should be triggered with the general principle which was outlined by Graham in his book - The Intelligent Investor - Sell when the reason you have bought no longer exist. ... written by bewise , December 29, 2006 Never drive a car without brakes. Never trade without a stop-loss. The difficulty is how to place it correctly. You must also use a trailing stop-loss to lock in your profits. That means you move your stop-loss up as the stock moves up. Show/Hide comment form Write comment Name Email Website Title Comment Copyright 2007. All Rights Reserved.
Last Updated ( Monday, 13 November 2006 )