Every trader should have a risk management plan in place before they start trading. A stop loss is a simple risk management tool that every trader should know and be able to use. There are several ways to implement stop losses into your daily trading. Depending on your goals and trading plan, not all stop loss methods might be the right one. Here we look at several stop loss methods so you can figure out which one is right for you.
A stop loss is a handy risk management tool that many traders use in their day to day trading. A stop loss helps to limit risk because it helps the trader see a limit that they have set for themselves. It is generally a number that a trader sets that tells them when they should exit a market. There are a few different ways to set this number.
The easiest way to use a stop loss is to use a fixed dollar amount. For example, a trader trading the E-mini S&P 500 might set a loss of $200 for his trading strategy. If one point on the S&P 500 was equal to $50, then this trader would know to exit the market after four losses. Four losses would mean a $200 loss on the overall account, and when the stop loss was reached the trader would know to stop trading and evaluate.
Another way to set a stop loss is to set a percentage of price as your loss. This is very popular with stock traders. Here is how it works: A stock trader might set a 10% stop loss on a given stock. Let’s say this particular trader buys a stock at $100. Because they are using a 10% stop loss, their stop is set at $90. Now they will look to participate in a move. If they are wrong, they know that they are going to get out with a 10% loss.
Other traders prefer to set technical stops. This kind of stop can be based on support or resistance patterns in the market. Imagine you are looking for a market to move up and you see there is a support level. Using a technical stop would mean that you would place your stop just below that support level. This kind of stop would allow you to participate in the trade and move to the upside. On the other hand, if you were expecting the market to drop, you would place your stop just above the resistance level.
The final method of setting stop losses was invented by Markus Heitkoetter, CEO of Rockwell Trading. In this method, traders place stops based on percentage of volatility. This method is very popular with traders who look at the average daily range of a market. A trader using this kind of stop will look at the average daily range, take the seven day average between the high and low, the session high band low, and use these numbers to determine the stop loss.
Stop losses are one of the best risk management tools a trader can incorporate into their trading. Not all stop loss methods might be right for every trader, but every trader should find a stop loss method that works for them.