What Is The Best Stock Stop Loss
Strategy For You?
By Trading Secrets
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, well 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, lets say that our stop size hasnt 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, lets 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 havent made any money, then youd be
right on track because remember our stock stop loss strategy gives the
share price a little bit of room to move.
Were not going to exit this position until the share price reverts to
one dollar. So, heres 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.
Lets go back to the example of superior stock stop loss strategy. Now,
what happens if the share price begins to fall? Lets 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? Heres 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, well lock in profit and well 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.
Its 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 were using the ATR method, theres 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
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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Stop Loss Strategy