May 21: Who Else Wants My Million Dollar Stop Loss Trading Technique

by Dave on May 21, 2006

When you first begin considering your stop losses, keep in mind this comment from Tom Baldwin, a leading day-trader. He said `the best traders have no ego.` Successful traders are faced with losses constantly, and they swallow their pride and get out of the position when they have to. This allows them to survive in the market long enough to be successful. They set their stop loss, and then stick to it.

How do you go about setting stop losses? There are several different ways. You could base your stop loss on a percentage retracement, where you allow share prices to retrace a certain percentage of the entry price before you exit. Different indicators can be used to identify where the stop loss is going to be set. You could also use support and resistance stops to set the level at which you`d exit. The key is to simply have a stop loss in place.

Personally, I find these options too subjective. I prefer having a mechanical way to calculate my stop losses, so I use a volatility based stop. The reason I use this type of stop is because volatility generally represents market noise. Consequently, if I measure the stocks volatility, and take a multiple of that value, I`m probably going to have set my stop loss beyond the immediate noise of the market. This ensures I am not stopped out of a position too often.

You can measure volatility by using the average true range of a stock. This value can be found with most charting packages. Basically, the average true range indicates how much a stock will move on average over a certain period. For example, if you had a one dollar stock that moved five cents on average over the last 20 days, that doesn`t tell us whether the stock is moving up or down. It just tells us on average how much the particular stock moves. The average true range is a great tool and can be utilized in your trading for more than setting stops. If you`re not familiar with it, I recommend you do a little bit of research to learn more.

How can you use this indicator in calculating your stop loss? By subtracting a multiple of the ATR from the entry price. For instance, I could take two times the ATR and subtract it from my entry price. If we look at the example I just touched on, with a one dollar stock, an ATR value of five cents and a multiple of two the amount is ten cents. Which, subtracted from our entry price of one dollar gives a stop loss value of 90 cents.

Before you even enter a position, you now know the point you are going to sell at. If the share price doesn`t move in your favored direction, and moves against you, you will know when to sell. Emotions are removed from the equation, and you simply follow what your stop loss dictates.

This is how most successful traders limit their losses. They know when they`re going to sell before they begin trading. Although their methods of calculating this stop loss may vary, they all have a stop loss in place. The stop loss is a crucial part of your trading system. Without it, even the best designed trading system can`t deliver profits.

This article has been extracted from David Jenyns` Trading Secrets Revealed Course. Unfortunately this course is currently sold out. To be notified if and when extra copies are released, please send us an email and we`ll let you know when you can purchase a copy of this highly recommended course. Click Here and send us an email. and be sure to mention you want to be on the `Trading Secrets Revealed Waiting List`.


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