prior to entering the market. Designing an effective stop-loss approach will
be crucial to increasing your profit potential.
If your trade or investment goes against you, a stop-loss approach enables
you to cut your losses quickly so that you have capital with which
to reenter the market. The alternative to using an effective stop-loss strategy
is to sustain severe and devastating losses at one point or another. The
market is unforgiving in this regard, and ignoring the inevitable is to tempt
fate and invite painful financial loss into your portfolio or trading account.
Following are seven of the most common stop approaches:
1. Initial stop. This stop is set at the beginning of your trade and entered
as you enter the market. The initial stop is also used to calculate your
position size. It is the largest loss you will take in the current trade.
2. Trailing stop. This stop develops as the market develops. This stop
enables you to lock in profit as the market moves in your favor.
3. Resistance stop. This stop is a form of trailing stop used in trends. It is
placed just under countertrend pullbacks in a trend
4. Three-bar trailing stop. This stop is used in a trend if the market seems
to be losing momentum and you anticipate a reversal in trend.
5. One-bar trailing stop. This stop is used when prices have reached your
profit target zone or when you have a breakaway market and want to
lock in profits, usually after three to five price bars moving strongly in
your favor.
6. Trend line stop. A trend line is placed under the lows in an uptrend
or on top of the high in a downtrend. You want to get out when prices
close on the other side of the trend line.
7. Regression channel stop. Very similar to a regular trend line, the regression
channel forms a nice channel between the highs and lows of
the trend and usually represents the width of the trend channel. Stops
are placed outside the low of the channel on uptrends and outside the
high of the channel in downtrends. Prices should close outside the
channel for the stop to be taken.
Other stops used are generally a form of one of the above stops or a
derivative of them. Setting stops will require judgment by you, the trader.
Judgment is based on experience and the type of trader you are. You will
set your stops based on your psychology and comfort level. If you find you
are getting stopped out too frequently or if you seem to be getting out of
trends too early, then chances are you are trading from a fearful mindset.
Try and let go of your fear and place stops at reasonable places in the
market.
Position your stops in relation to market price activity, and don’t pick
an arbitrary place to set your stop. Many traders incorrectly buy and sell
the same number of shares each time they trade. Then they choose a stop
so their loss is the same dollar amount each time they are stopped out.
By doing this, they are disregarding the meaningful market support and
resistance areas where stops should be set.
Remember, the ART software does an excellent job of identifying stop
signals, which are identified by choosing key levels of support and resistance.
This enables you to set stops that are in alignment with current market
dynamics.
Read More: 7 Basic Stops
