A Logical Placement Of Stop Loss
June 11, 2018
Stop loss! This is something that every trader hates to discuss. But unfortunately, this is what differentiates a successful trader from an unsuccessful trader. If you do not place your stop loss or do not know where to place the stop loss then you could be in trouble. In fact, everything about being profitable in the trading business is about placing proper stop loss and also managing it.
Stop loss lets you manage your risks. It is a small expense towards your business. You need to understand this to be green when trading.
You need to have a stop loss exit on each trade that you take. This is the core of risk management. Thus you know before every trade how much risk you are willing to take on each trade.
You are a risk manager
You can never say with certainty if your trade will surely be a winning trade. Nobody, in fact, can tell you this. It could be possible that you may be making some losses in a row and then eventually have a profitable trade that will cover up for all the losses.
Had you been sitting on the losses for days together then it would not only take your account deeper into the negative but would also have left you with no capital to enter a profitable trade.
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Thus placing stop loss is a must.
All of this said which is the right way to place a stop loss?
Placing a logical stop loss
Most traders will place their stop loss close to the high or low of the swing trade or a few points away from the entry price.
There are some who would place the stop loss based on how much they can afford to lose. So once they have entered the trade the stop loss would be placed such that they would not lose more than $100 on the trade.
These calculations are used by most traders but unfortunately, this is not the best way to place stop losses.
ATR method to place a stop loss
Most of the professional traders would use ATR to calculate stop losses. ATR is the average true range and this is a measure of volatility. It is calculated over a14 day time period.
A logical stop loss would be to place it below the support or resistance level on a long or short trade respectively leaving a gap of 1 ATR below the support or above the resistance levels. This is done because the support or resistance level is the area where you would have entered the trade. Thus if the price moves through it then probably the zone was not that strong.
You still, however, need to give the price some room to move about and this is why the stop loss is kept1 ATR away from the level.