If you’ve ever day traded stocks or futures, you probably understand the importance of using stop-loss orders.
Intraday price action can be significantly affected by algorithmic trading programs and it seems as if these trading programs are designed solely to hunt for stops. These often appear in situations where there’s a good trade, but you get stopped out on the high or low tick of a stop-hunting exhibition. Then you could find yourself watching as the market takes off again without you.
While this is an unfortunate reality of intraday trading, using the right stop placement may be able to do to minimize the chances of getting taken out of a good position prematurely. Adjusting your stop placement could make a significant difference in your results if you’re taking trades at support or resistance areas, or are trying to capitalize on momentum by buying breakouts or selling breakdowns.
Before going any further, you must understand that if you are initiating poor trades with little to no support, resistance or momentum to lean on, chances are good you are going to get stopped out regardless of where you place your stop.
Here are a few key considerations to keep in mind when placing stops:
- Don’t place your stop were there is likely to be a cluster of stops. That’s exactly what stop-running algorithms may be looking for. Either go tighter or go wider.
- Don’t place a stop just above support or just below resistance.
- Don’t trade with stops so wide the trade makes you uncomfortable.
- Don’t trade with stops so tight you get stopped out on almost every trade.
- Never trade without a stop.
- Do not place a stop at any area that might otherwise be considered a good area for trade entry.
- Use wider stops for larger potential moves and tighter stops for smaller potential moves.
The bottom line is when it comes to stop placements, you have to choose to use wider stops or tighter stops. While wider stops may be triggered less often, they do represent larger losses when they do. And even though tighter stops may be triggered quite often, they keep losses smaller.
Also, you must keep in mind that when using tight stops, you can always get back in a position after being stopped out.
Stop placement is largely a matter of personal preference. If you are trading for larger moves, you may want to use wider stops. If you are trying to scalp large share or contract sizes during the day, you may have to keep a very tight leash on your trades.
The mental toll from a small loss may be substantially less than the mental toll from taking a large loss even if tight stops being triggered can be frustrating.
The most important thing when it comes to stop-loss orders is that you use them.