Stop losses aim to end a trade when the market goes so far in the opposite direction, that the trade idea no longer makes sense. It’s the point of invalidation. Ideally, they get hit on bad trades only and not on good trades. The area between entry point and stop loss is a zone where the trade is at a loss, but can still recover. This is not an invalidation of the trade. It’s a balancing act: place the stop orders far enough beyond your entry point to give the trade room to breathe and allow the price to rebound in the profitable direction, yet close enough to it to protect your account against a big loss in case of an invalid setup.
When you put on a trade, you take a risk. Acknowledging this means accepting this risk and quantifying it before you enter a trade. Not using a stop loss, to me signals not accepting the risk and thereby increasing it because if you don’t use a stop loss your account becomes one. I see not cutting losses early as a fear based trading error. I always try to trade another day and stops give me piece of mind. Automatic stops are even disconnection and hardware problem proof. Everything in trading is a trade off, so there are disadvantages: when it is hit and price reverses, or if its placed wrongly.
My philosophy when managing a trade is that either I am right, or I should be out. So what is the ideal place for stop losses? Trying to answer this is like searching for Columbus´ egg. And I haven’t found it yet. It’s a personal decision and I have no overarching rule. For each play in my playbook, I describe where to put the stop loss. I don’t use a fixed amount of pips; in stead I let the trade setup conditions dictate its position. With 5-point retracement structures like the Bat pattern this would be beyond the X-point (because if price moves across this level, then it was not a retracement structure and if I am not right, I should be out).
For 2618 plays this would be beyond the tops / bottoms, for channel trades beyond the trend lines and for other plays I use support and resistance levels. I always put the stop losses at a certain distance of these invalidation points, as price may pierce through them before reversing. How far they are placed from my entry point varies, depending on the timeframe and the size and configuration of the pattern I am trading. I always adjust my position size so that in each case the amount of pips from the entry point to the stop loss represents my maximum trade risk (as a fixed % of my trading capital).
As a consequence the position sizes I use vary from trade to trade but my risk does not. So, for any winning trade, how much profit I make per pip is proportional to the distance between entry point and stop loss. The placement of a stop loss also influences both the win rate and reward / risk ratio and therefore the expectancy. So its placement is absolutely key. When I am in a winning trade, I roll the stop loss in the profitable direction to lock in part of the profit, thus ensuring the winning trade does not turn into a loser. The stop loss has now become a profit protection point and the trade has become a management of profit. As a rule, I must have hit my first profit target, before I can do this manual trailing.
These risk free trades, essentially trading with the markets money, are awesome. Rolling the stops in the opposite direction is a no-go: stops can only be tightened, never widened. I can´t talk about stop losses without mentioning "stop loss hunting”. This refers to situations when the market quickly spikes and hits your stop loss so you are out with a loss, only to reverse and continue in the direction you predicted. I will not get into whether it’s the broker, the banks or institutional traders that are behind this (looking for liquidity to fill their positions), but this price behaviour does happen and taking it into account pays off.
When you put on a trade, you take a risk. Acknowledging this means accepting this risk and quantifying it before you enter a trade. Not using a stop loss, to me signals not accepting the risk and thereby increasing it because if you don’t use a stop loss your account becomes one. I see not cutting losses early as a fear based trading error. I always try to trade another day and stops give me piece of mind. Automatic stops are even disconnection and hardware problem proof. Everything in trading is a trade off, so there are disadvantages: when it is hit and price reverses, or if its placed wrongly.
My philosophy when managing a trade is that either I am right, or I should be out. So what is the ideal place for stop losses? Trying to answer this is like searching for Columbus´ egg. And I haven’t found it yet. It’s a personal decision and I have no overarching rule. For each play in my playbook, I describe where to put the stop loss. I don’t use a fixed amount of pips; in stead I let the trade setup conditions dictate its position. With 5-point retracement structures like the Bat pattern this would be beyond the X-point (because if price moves across this level, then it was not a retracement structure and if I am not right, I should be out).
For 2618 plays this would be beyond the tops / bottoms, for channel trades beyond the trend lines and for other plays I use support and resistance levels. I always put the stop losses at a certain distance of these invalidation points, as price may pierce through them before reversing. How far they are placed from my entry point varies, depending on the timeframe and the size and configuration of the pattern I am trading. I always adjust my position size so that in each case the amount of pips from the entry point to the stop loss represents my maximum trade risk (as a fixed % of my trading capital).
As a consequence the position sizes I use vary from trade to trade but my risk does not. So, for any winning trade, how much profit I make per pip is proportional to the distance between entry point and stop loss. The placement of a stop loss also influences both the win rate and reward / risk ratio and therefore the expectancy. So its placement is absolutely key. When I am in a winning trade, I roll the stop loss in the profitable direction to lock in part of the profit, thus ensuring the winning trade does not turn into a loser. The stop loss has now become a profit protection point and the trade has become a management of profit. As a rule, I must have hit my first profit target, before I can do this manual trailing.
These risk free trades, essentially trading with the markets money, are awesome. Rolling the stops in the opposite direction is a no-go: stops can only be tightened, never widened. I can´t talk about stop losses without mentioning "stop loss hunting”. This refers to situations when the market quickly spikes and hits your stop loss so you are out with a loss, only to reverse and continue in the direction you predicted. I will not get into whether it’s the broker, the banks or institutional traders that are behind this (looking for liquidity to fill their positions), but this price behaviour does happen and taking it into account pays off.
You don´t need to be a weatherman to know which way the wind blows - B. Dylan
