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Sometimes offense doesn’t always mean you win the game

That’s why there’s a saying you might have heard before

Defenses win championships

While this might be true for Super Bowl Championships, it’s also a mindset shared by many traders.

If you ask most traders on Wall Street, they will echo a similar saying.  

While entries are important for all traders, it’s the way you manage risk (the defenses) that separates a good trader from a great trader.

And this starts with properly managing your trades and keeping your stops placed at the right level.  

 

What Is A Stop-Loss

 

As an active trader it is crucial to understand why and how stop losses are used to protect your trading account.

The stop loss order is one of the little things that are easy to forget about, especially when you’re in the heat of a trade.  

And then before you know it a trade is going against you and you take losses far larger than you wanted to.

What you’ll learn…

  1. All traders benefit from trading with either physical or mental stop orders
  2. Stop losses are designed to limit a traders loss on a position that goes against them
  3. Stop losses let you focus on other market events since you have an order that protects your account
  4. A disadvantage could come from placing an incorrect stop loss order, causing an unnecessary trade.

First, what exactly is a stop-loss?

stop-loss is simply an order that closes out your position at a specific price.  These orders typically control your risk by limiting your loss to the price set.

For example, if you buy a stock at $20 and place your stop-loss order at $18.00, your stop-loss order will be executed when the price reaches $18.00, preventing further losses in the event the market heads lower.  And if the price of the stock never drops down to $18.00, your stop-loss won’t get triggered, keeping you in your trade.

Pro Tip:  It’s important to make sure that you set all stop-loss orders to limit orders and not market orders.

Next…let’s take a look at where to place your stop-loss orders.

 

Where To Place A Stop-Loss Order

 

Similar to buying a stock, a stop-loss order on a long or short position should not be placed at random levels.  There is an art of giving the market that wiggle room to move around freely,  while still protecting your account from major losses.

With buying stock, a common stop-loss order falls just below the swing low price.  A swing low is created when a stock is rising and falling, and a swing low finds support at a price level in line with other swing points.

As a momentum trader, you want to make sure that you are trading in the direction of the trend.  This trend will be identified by higher lower swings being made.

Let’s take a look at an example of this trade.

 

Source: Tradingview

 

Assuming a trade was taken on the open of the day, you can see the stock ran higher.  Right after it made its first pullback and found a place to bounce, that area is called a “pivot”.

If you were trying to capture a larger move, ideal places to put your stop to allow a stock to run higher is right below each of the pivot lows.

It’s important to notice that when the market faded around 10:45 am to 11:45am, it never made it back down to the prior pivot low.  This meant that you gave your trade enough room to continue to trade higher.

But what if you wanted to keep the trade on a tighter leash?

Let’s take a look at how you could adjust your pivots to let you keep higher profits in the trade.  

 

Source: Tradingview

 

Pro Tip:  Having a tighter stop means you risk clipping your winners from running too early.  It’s a balance of just the right amount of risk management to keep profits and also let you capture enough profits.  

It’s all about the balance between risk and reward

Not into pivot levels?  Let’s take a look at alternative places for a stop-loss order to be placed.

 

Alternative Points For a Stop-Loss

 

Swing points not your style?

That’s ok!

The great thing about trading is that everyone has their own strategy and not any single one is better than the other.  Depending on your entry price and strategy, you might want to place your stop loss at an alternative spot on the chart.  There are plenty of other ways to handle stop losses on your trade that are more calculated compared with a pivot low.  

As a technical trader, there are many indicators that can be used as a stop-loss level.  If an indicator provides a buy signal, you can use that same indicator to provide an exit level.  If you wanted to combine indicators and have one for entry signals and one for exit signals, you can do that too!

Another great indicator to use for stop levels are Fibonacci Retracement levels.

 

Using Fibonacci Retracements As Stop Levels

 

When using Fibonacci as a stop-loss level, there is not a standard at which you have to follow.  This method is one of the more subjective stop-loss levels since it requires every trader to have their own unique viewpoint.

 

Source: Tradingview

 

As you can see the price moves lower , you would then determine the size of the pullback you are willing to accept and place your stop-loss exit that correlates to nearby fibonacci levels.  

In this example, to keep the most amount of profits we chose to use the 50% retracement for the stock.

Setting the exit at the next Fibonacci retracement is the most restrictive exit you can place, and should only be done if you are really confident that the support and resistance area will hold.

 

Using VWAP As a Stop-Loss

 

Using the Volume Weighted Average Price(VWAP) when trading in shorter term markets and day trading is a very effective strategy.  

First, why is VWAP important?

There are many reasons why VWAP matters for a trader to at least have reference to.  

Here are some benefits that make sense to me.

  • VWAP is a simple indicator
  • It builds in value, to give you a representation for where the average price is with volume
  • Stocks performance is built on periodicity instead of cumulative market data.

Here’s an example of the VWAP and how it gives you an area where the market broke down on.

 

Source: Tradingview

 

As you can see, this exit strategy gave you the most “wiggle room” for the trade to work as it ran rigger throughout the morning.

Conclusion

 

And that’s all it takes to successfully place a stop-loss order into the market

It’s important to remember that buying a stock, a stop-loss order on a long or short position should not be placed at random levels.  

There is an art of giving the market that wiggle room to move around freely,  while still protecting your account from major losses.

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Author: Ben Sturgill

Ben leads two services at RagingBull. IPO Payday can help you pinpoint, position, and profit from IPOs. In Daily Profit Machine Ben guides day and swing traders to profit by trading the SPY Index. Ben hosts the RagingBull.com weekly podcast WealthWise where he shares thoughts on wealth and success with traders, businesspeople, entrepreneurs, and experts to uncover and share the wisdom needed to live a wealthy life.

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