How to Place Stop Loss Orders

Place Stop Loss OrdersA trader uses stop loss orders to exit the trade when the market starts to move in the opposite direction and the trader looses money. Although many traders don’t do it, it is advisable to use stop losses with every trade, no exception. Arguments against the use of stop loss orders can include the low profit when using them, but if you know how to use the stop loss orders, this can be avoided. For example, you can place them at some less obvious prices, not where everybody else places them. Traders use these stop loss orders as emergency exists as in the case of crash stops or just as regular exits.

How to place stop loss orders correctly

Stop loss orders can be correctly placed in two distinctive ways. There is a method more suitable for the discretionary type of traders and another method suitable for the system traders. Depending on what kind of trader you are, you should choose one of these two methods. If you still don’t know your trading type, here’s how to make the difference.

The method used by discretionary traders implies placing a stop loss order at that market price at which the trader doesn’t expect the market to reach. This price is the one that would change the market’s direction if it is traded at. The strategy behind this stop loss order placement is not to allow the trader to go any further with the trading if that price is reached, because the trader wouldn’t be in trade any longer at that value. What the stop loss order does is to exit the trade when that point is reached.

The method for system trading is based on the win to loss and risk to reward ratios. Concretely, if the win to loss and risk to reward ratios in your trading system point out to ten ticks behind the price of entry as optimal stop loss distance, then this is where you should place the stop loss order: at ten ticks behind the price  of entry that you established. This is a mathematical based method, so direction doesn’t influence the decision of placing the stop loss order.

This system trading method for stop loss order placement has an alternative method which uses indicators. It is possible to identify a certain indicator pattern which gives you the best trade exit in your trading system. Therefore, this is where the stop loss order should be placed, based on the indicator pattern and not on the  win to loss and risk to reward ratios. Concretely, if the win to loss and risk to reward ratios.

How not to place stop loss orders

Stop loss orders can be placed in many wrong ways which seem to occur more and more each day. Still, there are some which have a larger incidence.

There are traders who place their stop loss orders behind their entry price at a fixed percentage distance. For instance, a trader enters a long trade at  1,250. If the trader establishes the stop loss point at 2% behind the entry price, this point will be at  1,225, which is 25 points behind the entry price.  The percentage used to determine the stop loss order point may be related to the trade’s value (price multiplied by shares number) or the entry price of the trade’s target. However, no matter on how you calculate this percentage, the stop loss order point established this way won’t be related to the market dynamic, so it is not a good method to place your stop loss order.

Other traders choose to place stop loss orders arbitrarily at random prices. Such stop loss orders are just attempts to place the stop loss orders at some not so obvious prices. Still, choosing randomly and correctly is not an ability mastered by humans, so traders may only have the impression their choice was random, when, in reality, it fallows a pattern, such as always choosing round numbers. As in the previous case of percentage stop loss orders, these too don’t reflect the dynamics of the market. Moreover, these stop loss orders based on random prices cannot be tested. Thus, there is no indication of a possible success or loss.

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