It is obvious that we must constantly repeat: the presence of Stop Loss on current positions for a trader is comparable to the presence of the parachute for a person who has just jumped from a plane: do not have can be fatal! Game over …
You have all read, heard and perhaps even experienced that each open trade must be accompanied by a worst-case scenario, which is materialized by this famous Stop Loss. The worst happens when the stop loss is hit: not before or after! The whole game is the determination of this worst …
These stop losses can therefore be set according to different modes. I will here classify them in a very subjective way, starting from the least desirable for you to the most preferable. This is only my opinion. Feel free to react if you have other techniques, if you disagree with mine or if the order of preference that I suggest is not appropriate for you.
No real stop loss and at best a mental stop loss
What is a mental stop loss ? It is a barrier that you have fixed in your head (ie it exists only in your mind and nowhere else) and that you may transform into real action when it is affected by lessons.
Come on, we all did it, right? And in most cases, it does not work, does it? Why ?
Because our imperfect and fallible human brain does not like to be wrong. What happens then, in most of the time, when the course will reach this level of mental stop? There is a very good chance that you will not really activate it because you will go into “hope” mode. Listen to the little voice that speaks to you: “You’re not wrong, it’s going back up, it’s on …”
The mental stop is a perilous technique, one must be aware of it. For example, this technique requires that you are ready to intervene as soon as the level is reached, whatever the conditions in which you are. In other words, at this moment, any failure is prohibited, whether it comes from you (your availability, your own mind or your will) or external conditions (your internet connection, your trading platform, your PC, … ).
But it’s better than having no SL at all, neither on the platform nor in the head …
No formal Stop Loss defined in advance because you are in “Stop and reverse” mode
This mode makes you always in position and alternate according to an indicator. For example, you may decide that this will be the signal from the MACD that will serve as an indicator to follow (strategy not to do in reality, but that I give just to illustrate). You will thus open a position as soon as your signal is positive, and you will close this position and open a new one in the other direction simultaneously, when the signal becomes negative, whether your position is winning or losing.
Thus, with each passage of the MACD by zero, a stop loss or a take profit (as the case may be) is thus activated in this way of doing things.
Stop Loss only based on a level of risk
Say you have a capital of 10,000 euros, you want to open a trade of a lot, and you do not want to risk more than 200 euros (2% of initial capital). This requirement will set a SL at 20 pips for a standard lot (10 euros the pip), the calculation is simple.
What you have achieved is good, and this is often indicated in Money Management best practices. Only here, there is better …
A Stop Loss determined technically by the reality of the courses
This will determine your SL level using technical indicators that will reflect the realities of the course, and then, depending on your Money Management, determine the size of your position.
This is very different from the previous point, in the sense that you do not fix your SL on a simple mathematical calculation (function of the capital, the risk and the size of position) but on a technical reality of the courses. Moreover, it must be emphasized, in terms of money management, that you take the same risks as in point 3.
For example, there are two indicators that I particularly like to set Stop Loss:
- the Average True Range ( ATR ) which is an ultra-classic indicator that gives a good idea of price volatility. Taking between 2 and 3 times the ATR (average of 5 to 10 candles) usually gives good results (the course can breathe …)
- the last highest for a SELL (or lower for a BUY) with a margin of a few pips, to respect the famous principles of the Elliot waves (as long as the highest and the lowest are the highest, the trend is positive). It is enough that a lower one makes a lower for this tendency is questioned
It is also strongly recommended to check that these higher or lower correspond to supports or resistances of the course. If so, their SL function will be further strengthened.
This last way of doing things is, in my opinion, complete because it takes into account:
- the reality of the market by taking volatility indicators or psychological thresholds (higher, lower, supports and resistances)
- a serious money management, with the determination of the size of the position to be opened according to the calculated SL and the risk taken
Two things that it is wise to respect if you want to last on the financial markets!
And you, what is your experience in managing Stop Loss?