3 Types of Stop Losses

Today’s topic is going to be on three types of stop losses. This is a very critical topic because stop losses come under the category of risk management.

Risk management is such a pivotal, important and critical topic. Why? Because professional traders and investors, the first thing that they always do and constantly think about before they get into a trade or investment is not how much profit they’re going to make, it’s how much they can afford to lose.

The only control that you have when you enter into a trade and you’re in the trade is the risk factor because most of us will not have the capital power to control that trade. It’s a collective pool of people’s thoughts and a lot of other factors that come in which then determines how the price moves in the market, especially how smart money enters the market actually. So in light of all of that, the real power that you have, the real control that you have is your risk management. How much you can afford to lose. In terms of that, we’re going to be looking at the three types of stop losses and how to stop your loss when the market does something which is not favourable to you and not in line with the direction of the trade that you are taking on.

The first type is what we call the technical stop. This is the one most people will be familiar with. That’s where all your different kinds of stop losses come under: moving averages, channels, trend lines and so forth. All these are summarised under technical stop losses. Even if you use tier based stop losses, they come under technical stop losses.

The second one is called a money stop. A money stop is basically one where you write in your rules, and this is how you execute a trade as well is that you say, for example, you enter a trade and it is going well in profit. You tell yourself to trail your stop loss to break even as soon as the trade is 3% in profit. You don’t care what the moving averages are or where the price pattern is whatsoever, you would just move your stop loss to break even. So that is purely based on money. That is called a money stop because the stop loss is adjusted according to your profits or your losses. Usually it’s to your profits – that’s when you trail and adjust your stop loss.

The final one is the time stop. As you’ve already guessed, the time stop is based on time. Especially for intra-day trading it’s very important because you know certain times of the day volume is really high and other times of the day volume starts to dry up. So especially if you want to capture a certain percentage of move, you want to capture it before a certain time and you usually know that after 5pm or 6pm the volume usually dries up. Price movement is not really that much especially towards 9pm. So you can have a rule saying, for example, at 5pm or 6pm you’ll look at exiting a trade if it’s not reached an objective. If you’re a swing trader you start saying things like you know if it’s consolidating for 10-15 days in a row I will possibly exit out of the trade. So all that is basically based on time.

Let me ask you a question. Out of all the three stops I’ve talked about: technical, money and time, what do you think is the strongest stop of them all? I think, if my guess is right as we have coached thousands of traders, most of them usually tell me it’s either the technical or the money stop. In fact, let me tell you Traders, the weakest one of them all is the money stop because there’s no basis for it. It’s just based on money and just trailing it. The strongest is the time stop because everything is determined on time and you’re time bound in everything that you do. If you look at daily activities: waking up, going to work, having meals, going to bed – your life is time bound.

Here’s the final most critical point. If you actually want to make your risk management really strong, the trick is not to put emphasis on either one of them according to strength, but to make them sync with each other so that they can then adapt to market conditions. It’s basically a confluence of the types of stop losses that can help you to generate the rules which can adapt to market conditions. For example, when you start out if you put in your initial stop loss in a technical place and as time then moves by then you would then get more aggressive with your stop loss and as it’s nearing towards exit, if you’ve reached a certain profit potential as the market price is still hovering around, losing momentum, then you would then start to go into money stop. Money stop is especially useful if you’re in swing trading. For example, when we took the DOW Jones trade and we took that 2,000 point move on a mismatched strategy when it had already done 80% of the move we used a money stop because we don’t want to give back all that profit back to the market. So that’s when we start to us a money stop and a combination of time stop, initially starting with a technical. So that’s how you do it.

Do have a good think about this because this is so critical Traders. If there’s only one thing you have total control of, it’s your stop loss, it’s your risk management. So contemplate this, revisit your strategy rules and see how you can optimise that for maximum performance of your strategy.

I believe that you have really enjoyed this topic and have some amazing value from this. Until the next time, as we always say, stay disciplined, follow your trading plan and keep trading like a master.