Possible stop loss strategies to consider

Many of you know that there are MANY different investment and trading strategies and to be honest there is no such thing as the perfect model. Different things work for different people. Investment strategies depend on things like your age, risk profile, debt level, capital amount, emotional capital and the type of person you are. And if you are a trader, your strategy will be different to that of a long-term investor.

Keep in mind that as a trader you must first determine your stop loss before you get into the position, so that you can determine your position size for that trade. The stop loss will determine how many contracts/CFD’s you will be trading. Make sure you know how to determine your risk/reward ratio, to ensure the trade is worth your effort.

Keep in mind that the stop loss is used as a line in the sand which will reasonably indicate that the trade might be wrong, and NOT necessarily at the point of where you will be comfortable with the maximum loss on the trade. 

This blog post is aimed at traders who want to use stop losses, and who want to get out if the share starts to look weak and they are not keen to build a position.

Step 1 is to know what the average true range (ATR) of the share is. This indicator is not an overbought/sold or sentiment gauge but literally the average moving price of the share over your time frame. This means that if you add the ATR to your daily graph and it shows R3-50 (the level appears usually on the left-hand side of the indicator where you can change the settings), it means that the share has moved on average R3-50 over the past 14 days. The default setting on an ATR is usually 14.

This will also avoid the pitfalls of using a fixed points/Rand amount on every trade. Instruments/CFD’s differ massively in their volatility.

How can you use the ATR, to determine your stop loss?

Make sure your stop loss is at least bigger than the ATR on the daily graph.

You can multiply the ATR by two and use that as a stop loss level from your entry price.

Step 2 is to know where the strong support or resistance levels are on the graph. You want to place your stop loss beyond these critical levels, not on them. Remember, two touching points on the real body or wick of the candle is seen as a temporary line and three and more touching points is seen as a strong trendline. Draw these trendlines so you can see where the levels are, but remember too many trendlines will feel overwhelming, so use whatever you are comfortable with.

You can identify the previous strong support/resistance on the graph and add or subtract the ATR to that level depending on whether you want to go long or short on the instrument.

Use a moving average to identify strong support or resistance which can be used as a protection level for your trade. Keep in mind that short-term traders use 3 & 8-day moving averages and medium-term investors use 26 & 9-day moving averages. Again, make sure you are beyond that moving average(s) and not on top of them. Give a possible move some breathing space.

A breakout on a strong support or resistance trendline can also be used as a stop loss level. Keep in mind that sometimes one gets a “wipsaw” (also known as a false breakout) which means that the trendline gets broken but after a few sessions the price moves back into the range it previously was.

Remember, your stop loss cannot be too tight, it just increases your risk of being taken out too soon.

You can also add different time frames for the graph to identify even more support or resistance levels. A combination of a daily, 4-hourly and hourly graph for example. Keep in mind the support/resistance on your daily graph will weigh the heaviest when making your decision.

Another thing you can consider is to make your graph a line graph which removes the overall noise in the graph so that you can get a smoother picture of the price action of the instrument.

Remember do not try to “catch a falling knife”. Wait for the price to stop making lows before you buy. Remember too, nothing always goes up, wait for confirmation of weakness before you start to short sell.

I hope this will support you in your stop loss strategy.