Why Is Setting Your Stop Loss So
the best ways to calculate your stop loss.
By Trading Secrets
The way I go about setting my stop loss for longer term systems is
by using a volatility based stop. The reason Ive used this type of
stop loss order is because I believe that volatility usually represents
Consequently, if I have a way of measuring volatility, and I take
a multiple of that value and subtract it from my entry price, Im
probably going to have set my stop loss beyond the immediate noise
of the market. I personally find this the most effective.
So, let me show you how I go about calculating my stop loss.
The way in which I measure volatility and set my stop
loss is by using the average true range. Now, you can get the
value of the average true range out of most charting packages. Very
simply, though, the average true range is a measure of volatility.
It indicates how much a stock will move on average over a certain
So, if you had a one dollar stock that moved five cents on average
over the last 20 days, that doesnt tell us whether the stock is going
to move up or down. It just tells us on average how much the particular
stock moves. The average true range really is a fantastic tool and
can be utilized in your trading for more than just setting your stop
loss. So, if youre not familiar with it, I recommend you do a little
bit of research because it can be a great tool.
So, how can we use this indicator in calculating our stop loss? All
you do is you subtract a multiple of the ATR from the entry price.
I might take two times the ATR and subtract it from my entry price.
Now, what that means is if you look at the example I just touched
on before, if we had a one dollar stock and its ATR value was five
cents, I would simply take a multiple of the ATR which I said well
use two in this example, and wed subtract it from our entry price.
So, two times our ATR is ten cents, subtracted from our entry price
gives us a stop loss value of 90 cents.
Now, by adhering to this pre-defined point at which I set my stop
loss, I know that if the share price doesnt move in my favored direction,
and actually moves against me, I already know the point at which Im
going to sell. My emotions are removed from the equation, and I just
simply follow what my stop loss says. This is how most successful
traders limit their losses. They know when theyre going to sell and
they have this pre-defined before they even begin trading. Although
their methods of calculating this stop loss may be different the one
common element here is that they have a stop loss in place.
Heres a little extra finesse point that you might look at including
in your trading plan. I sometimes introduce my stop
loss depending on the type of system Im trading. This type of
stop loss simply takes you out of a position after a fixed amount
of time if I havent made enough profit.
To successfully implement this type of stop loss, youre going to
have to do some sort of back testing, to find out if its appropriate
for the particular instrument youre trading. I just thought Id throw
that in there to make sure you have all your bases covered.
When you first begin outlining your stop losses, just keep in mind
what Tom Baldwin, the successful trader said. He said the best traders
have no ego. You have to swallow your pride and get out of your losses.
Hes simply referring to having a stop loss set, and more importantly,
having the discipline to stick to your perarranged stop loss.
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