Different Types of Stop Loss Approaches in Trading
Different Types of Stop Losses in Trading
If you ask any successful trader the formula for his success, you would hear all the mundane proverbial statements that those traders swear by. However, newbies have a hard time digesting the fact that immense trading success can come out of simple but boring rule-following.
Especially, one rule that all successful traders swear by and newbies ignore is cutting the trading losses short when they are small.
Losses are painful. Nobody wants them because it’s an acceptance of being wrong and being wrong is a psychological evil. But, successful trading entails taking losses, a lot of them in fact.
Therefore, it's vital for all the traders to make peace with losses.
Taking losses isn’t as straightforward as it sounds. One must have rules to determine when the trade has gone sour to not kill a trade prematurely. Rules are essential to determine stop-losses, because, without rules, emotions will dominate your decision making, which will hardly produce the right outcome.
To help you with that, here are some frameworks that can help you formulate a few stop-loss rules for your trading.
Initial stop loss after entering a trade.
Your initial stop loss must be decided before entering the trade. You must set this stop loss keeping in mind the kind of reward you are gunning for.
Your percentage stop loss on any trade should be half or less of what you expect to gain from the trade. Under no circumstance, the stop loss should be higher than your average gain in your winning bets.
The best traders set their stop loss based on technical analysis. They observe how the chart has set up and determine their stop loss based on price breaching critical levels or the price behaviour becoming abnormal.
For example in the chart below, the ideal buy point for a breakout trader would have been when the price closed at a new high, with the stop loss close to the support zone towards the low of the set-up.
Sometimes the set-up would not have a low-risk entry point and the support zone could be too far from the buy price, in which case, you can set an absolute percentage as stop loss (not my recommendation). The absolute percentage, in this case, can simply be the average stop loss from your own historical trading.
Time stop: Avoid non-moving trades