How to use Stop Loss properly
It is true that many traders specialists recommend using Stop Loss(SL ) for a risky market (in our case of futures, options and short selling), since this technique limits the risk of losses.
What are the factors that trader must take into consideration when setting a SL?
1. How much trader accepts to risk?
SL does not always guarantee that the election will be executed on the set because there are gaps, but these are rare exceptions and somehow are accepted. When a trader estimate an investment he must have a plan that include possible situations when price will goes against the direction chosen, which creates a potential risk for loss.
It’s popular among traders that the risk should be between 6-8% below the price of entry (if the positions are long) and over the price of entry (if positions are short).
Other traders use support levels (following the technique pivot point or Fibonacci levels) and then SL will be set below this level, especially if it was tested 2-3 times and every time you made a rebounce over it.
Both methods are valid because they correspond to the value of risk assumed by the trader.
Another option is when SL was established under the support line and then the trend has a bounce. In this case, it’s advisable to wait until for the new direction to be confirmed and the next day (i.e. to consolidate) and then move SL with the same percentage under the new support line.
This movement is executed by some traders daily or weekly and choice belongs to every one of them depending on the methods of implementation and the results.
2. What are support and resistance levels of the trend?
As it was already shown above this depends on the method chosen. Many times, perhaps through careful market makers, the direction tends to reach the stop loss line and also often break the line giving feeling that direction of the trend will go down even more but so as it lowers the trend line will get above the SL line and the support lien as well. Certainly this SL will run automatically with that loss.
This thing makes the market become very volatile and increase the interest of traders in the market again, increase liquidity which was actually reduced.
Perhaps for these reasons many traders do not use SL in a market with low liquidity but with a big enough volatility.
If you choose a bullish market of course you will set the level of the first resistance, which in turn will become the first target. Thus we will consider how far is this target from the enter place and will set the level of the first exit. Many traders set this target in a subjective / emotional way.
There are ways to determine the distance to the final output (reward), which is approx. 2.5 times the distance from the first exiting (first reward). In this case we have a potential target for a hazard ratio.
The risk is that you can not reach the target because the trend changes direction again (happens a pullback) and then you should take care to set before SL of the chosen level of resistance, and if you see that trend has penetrated this level you should go along with it even if the target was exceeded. Of course you will consider moving the SL corresponding to the new trend movements.
This being said we should bold the idea that choosing and setting up the right SL it’s not always risky if you are aware of the methods how to do it properly. Hopefully ideas shared above will help you to perform this task greatly and to get high results in your trading experience.
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