Three Tips On Setting Effective Stop Losses

Provided By Ultimate Trading Systems

Setting Effective Stop Losses Is A Crucial Part Of Successful Trading

Everyone needs to set stop losses. But there are no hard and fast rules to follow - you need to develop a system that fits your trading style, and follows your trading plan. However, there are a few tips I can share with you about setting stop losses. Keep these in mind as you practice and cultivate the skill of setting stop losses.

First, find out if your broker has rules about where and how stop losses are set. For example, some brokers have a rule that protective stop losses must be set at least a minimum amount below the current bid when you're long, a stop sell, or above the current ask when you're short, a stop buy-to-cover. The rule may be that a stop losses sell order must be at least .25 below the current bid.

This isn’t usually a problem with a high-priced position. But with a very cheap position, you might not be able to set tight stop losses unless you wait for the bid to move up. In addition, if the price of a position is dropping quickly, the bid may come too close to the stop losses you're trying to place before you're able to place it. Which can cause your order to be rejected. Another rule some brokers have is that stop losses can't be set more than a certain percentage lower than the current bid or, on a short, higher than the current ask. They may specify that stop losses be set no more than 30% lower or higher. I have no idea why you'd ever want to lose 30% of the value of your trade before stopping out, and would never recommend setting stop losses that low.

My second tip is to always review orders carefully before placing them. You'd think it would be impossible to place a limit order when you mean to place your stop losses, but it’s easy to do when you’re in a hurry. You need to make sure you don't enter a limit order out of habit when you mean to place stop losses. If you place a limit sell order at a price below the current bid, at the place where you meant to place your stop losses, it will execute right away and you'll be out of the trade. And since successful trader generally use limit orders to enter a position, it’s not surprising that many traders have been known to place two limit orders in a row.

And last, don’t leave stop losses in place overnight. Many markets are volatile at opening. Most mornings, for instance, NASDAQ stocks either gap up or gap down from their prices at the previous day's close, and then they swing pretty wildly as overnight market orders are filled. For example, a stock could close at 33, open the next day at 32.80, drop to 31.94, and then bounce back up to 33.15 before stabilizing and finding its direction. It could also close at 33 after a good day, open the next day at 33.75, spike up to 34.50, and then drop back to 33.60. The possibilities are endless.

If you have a overnight stop losses in place on a long position, it's likely to be triggered by the morning's volatility, which will stop you out at the low end just before the stock bounces back up. Remove your stop losses after the market closes, and reset them after the opening fluctuations the next morning so they will protect you from real downside rather than routine volatility.

You might also consider doing what lots of traders do, particularly when the market has no consistent direction. Avoid holding many positions overnight. Once you get better at anticipating what will probably happen the next day, realizing that there can always be overnight surprises, you'll feel more comfortable setting your stop losses.

As always, if you don't have a pretty good idea what will happen, it's best to avoid the situation, and stay out of the position. In addition, if you'll be unable to trade for several days, consider whether it makes more sense to set stop losses or to exit your positions altogether. Unless you're in a great long-term trend trade and the market has a definite direction, it may be better to exit all positions and start fresh when you return to trading. Your capital and profits will be safe, and new trading opportunities will be waiting for you.

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