What Is The Best Stock Stop Loss Strategy For You?

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Using a stock stop loss strategy to calculate a trailing stop loss? (Part 2)

The key to the trailing stop loss is that you need to have a good stock stop loss strategy and continually make adjustments to make sure that the stop is moved in your favor. Of course, the way in which a trailing stop loss is calculated is very similar to the way in which we calculated our initial stop loss. The only difference in this stock stop loss strategy is that rather than calculating our trailing stop loss from the entry price, we calculate our stop loss from the highest price since entry.

The stock stop loss strategy that you use can vary dramatically, however if we use the ATR method that we used to calculate our initial stop as our trailing stop loss, we’ll have the ability to lock in the profit as the share price increases.

An example of a good stock stop loss strategy, if we bought a share at one dollar, and our initial stop is set at 90 cents, if our initial stop is equal to our trailing stop, our trailing stop would lso have a value of 90 cents. If after the first day, the share price moves in our favor and moves to $1.10, the next step would be to grab the value of the ATR and subtract two times this from our highest price of $1.10.

For the ease of this example, let’s say that our stop size hasn’t changed, so our stop is still ten cents wide in this stock stop loss strategy. When we calculate our trailing stop loss, our new trailing stop loss would be set at one dollar. So, let’s take a stock take. Take our initial stop was at 90 cents, our trailing stop loss is now a dollar, and our share price is at 1.10. Since our trailing stop loss is higher than our initial stop, the initial stop becomes obsolete, and our trailing stop loss now becomes our active exit.

Now, my question for the astute listener is to ask, “How much profit have we made on this trade?” The share price is at 1.10 and we entered at one dollar. If you thought, “No, we haven’t made any money”, then you’d be right on track because remember our stock stop loss strategy gives the share price a little bit of room to move.

We’re not going to exit this position until the share price reverts to one dollar. So, here’s an important point to note on this particular stock stop loss strategy, when valuing any open position, always value that position based on its stop loss value because if we were to exit this share, we would wait until that price point was breached.

Let’s go back to the example of superior stock stop loss strategy. Now, what happens if the share price begins to fall? Let’s say that the share price falls from 1.10 down to 1.05. What does our trailing stop loss do? Would it move down also? Here’s another important point to note. A stop loss will never ever move down. A trailing stop loss can only ever move up. In this way, we’ll lock in profit and we’ll also get out of shares once they start to turn. A trailing stop loss is always calculated from the highest price since entry, so the highest price is still 1.10.

It’s not until the share price makes a new high since entry that the trailing stop loss would begin to move in our favor again for this particular stock stop loss strategy. If we’re using the ATR method, there’s another way for our trailing stop to move up. This alternative method would occur when the volatility of a stock begins to shrink. So, if a share price begins to move sideways, the affect would be that the ATR value would begin to drop off. This would also obviously mean that the trailing stop would begin to move up as the share price came less volatile in this particular stock stop loss strategy.

The best way to get a grasp on this stock stop loss strategy is to print out a chart with ATR value along the bottom, then on a chart, identify the point where you would have received an entry signal, then on the chart mark your initial stop loss and also your trailing stop loss, as the trade progresses make sure that you revalue the value of your stop so you can begin to get a feel for the way this method of calculating a stop loss works.

Also, in this type of testing, you may wish to test the effects of this stock stop loss strategy having a wider trailing stop loss then an initial stop. This is one of those finesse points that you could add to your stock stop loss strategy that may squeeze a little bit more profitability out of it. For example, what you might look at doing is setting a two ATR stop loss for your initial stop, whereas you might set your trailing stop loss as three ATR.

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