Almost every time we talk about risk management, we emphasize the importance of using Stop Loss orders to limit potential losses and avoid trading disasters.
However, setting Stop Loss orders the wrong way can turn up being even more damaging for your account than natural losses. For that reason, we would like to go over a few points that will guarantee a more accurate setting of them.
Definition (Source: Investopedia)
“A stop-loss order is an order placed with a broker to sell a security when it reaches a certain price. Stop loss orders are designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order with a long position, it can also protect a short position, in which case the security gets bought if it trades above a defined price.”
Now that we have refreshed our basic knowledge of what a Stop Loss actually is, let’s move forward with key advices that will help you set them for success:
Give them some space, but not too much
Setting Stop Loss orders too close to the price is a risky move. We get it. You want to protect your position and avoid losses, but you cannot forget about natural volatility. Quotes need space to move up and down, fluctuate and eventually resume upward or downward trends.
If you don’t take into account that volatility and set SLs too close to the price, a meaningless movement could trigger the order and leave you empty handed for no real reason.
Don’t focus on pips or cash
You cannot rely on a random number of pips or profit to define your SLs. Instead, you should rely on technical analysis and understand which are the support and resistance levels in play.
If you pick up your entry levels based on technical analysis, why would you do the complete opposite when it comes to your stops? Exactly, nonsense.
Support and resistance levels are not good enough
Sure. You have to keep support and resistance levels in mind when setting SLs. But that doesn’t mean you should set them in support and resistance levels. It’s a bad idea. Try putting them a bit below support and above resistance to avoid false breakouts.
