An example of setting stop loss
Setting stop loss is one of the hardest thing for new traders to learn how to do. This is because it really is an art. There are all sorts of rules about how to set stops, but these rules don't always take into account the trading context.
Why do we need to set stop loss?
There is no such thing as a guaranteed trade. Every trade is a bet on probability. (Every investment is a bet on probability for that matter.) Therefore, we need to figure out ahead of time when to call it quit if we are wrong about a trade projection, or if the market suddenly turns against us. Setting stops is like wearing a seat belt while driving. It is there to protect you from bad scenarios.
Setting stops using the percentage method
Traders who trade lots of positions at once tend to prefer this method because it's easy to track. To use the percentage method, first we need to decide on the Reward:Risk ratio that we are willing to embrace for a trade. In general, the R:R ratio should be at least 3, preferable higher for a trade. Using an R:R ratio of 3, if we expect to make 3% profit on a trade, then we set the stop loss at 1%.
A case study on how we set stops
For us, we use a slightly different approach. Before we set a stop, we need to understand the reason that prompted us to enter that trade in the first place. So we want to drill down below and explain some very specific scenarios and how we set stops.
Below is TNA daily chart. It shows a pattern indicating that TNA is potentially breaking out. Volatility has been trending down, and market breadth has been improving. It's a bullish buy-the-dip market, not one verging on a crash.
Why do we need to set stop loss?
There is no such thing as a guaranteed trade. Every trade is a bet on probability. (Every investment is a bet on probability for that matter.) Therefore, we need to figure out ahead of time when to call it quit if we are wrong about a trade projection, or if the market suddenly turns against us. Setting stops is like wearing a seat belt while driving. It is there to protect you from bad scenarios.
Setting stops using the percentage method
Traders who trade lots of positions at once tend to prefer this method because it's easy to track. To use the percentage method, first we need to decide on the Reward:Risk ratio that we are willing to embrace for a trade. In general, the R:R ratio should be at least 3, preferable higher for a trade. Using an R:R ratio of 3, if we expect to make 3% profit on a trade, then we set the stop loss at 1%.
A case study on how we set stops
For us, we use a slightly different approach. Before we set a stop, we need to understand the reason that prompted us to enter that trade in the first place. So we want to drill down below and explain some very specific scenarios and how we set stops.
Below is TNA daily chart. It shows a pattern indicating that TNA is potentially breaking out. Volatility has been trending down, and market breadth has been improving. It's a bullish buy-the-dip market, not one verging on a crash.
We had managed to capture TNA surge on 8/27/21. We went flat over the weekend and now want to see if TNA is ready to resume the rise. So we use TNA 5-min chart below to target our entry. See annotations on chart for our stop-setting strategy.
As TNA moves up, we will have to decide on a day-to-day basis where short-term support lies and place our stop just below that. In a highly bullish market as shown above, we can use the 200 EMA on the 5-minute chart as the key support level for setting stop loss.