by Joe Duffy

Setting Stop Loss Points

The stop loss point is that where if the market gets there, then the trade is likely wrong.  A stop loss order is an order that when a certain price is hit, the order becomes one to exit the existing position at the market.  If you cannot watch the market intraday, you will need to place a stop loss order to limit your downside risk in any trade.

If you are buying a level of support, put a stop loss order below the next level of support.  If you are selling a level of resistance, then put a stop loss above the next level of resistance.

I generally avoid putting my stop loss orders too close to my entries.  Statistically, this virtually guarantees you will be stopped out a lot, and 4 or 5 small losses can quickly equal one larger one.  So how close is “too close”?

To answer that question I have done a lot of empirical testing with various entry techniques and stops.  I have found that using the concept of average true range or ATR can be a big help here.  Specifically stops less than one ATR – that is, basically the average daily range over say a look back period of 20 days, is too small a stop.  You tend to get stopped out on what is just “noise” too often.  Two times the ATR is a good stop level in a lot of my testing.

What I do is combine the concept of ATR with the techniques I use for support and resistance to come up with a stop loss point.  That is in most cases I find a technical point that I don’t think the market should break.  If that is the one to two ATR’s away from entry point then that is likely a good point for my stop loss.

Taking Profits

I believe that most of the time, and with most of your position, you are better off taking profits while the market is going your way.  That is, if you are long, sell into a rally to take a profit.  If you are short, buy into a decline to take a profit.

That may be contrary to what you have heard about “letting your profits run”.  But experience has taught me that “letting it run” means about 80% of the time it will run back against you!  And that just cuts your profits, not increases them.

If you think about the nature of the markets, this makes perfect sense.  At least 80% of the time markets are range trading.  They are only trending strongly enough to the point where a trailing stop will not get hit, at best, 20% of the time.  So a short term swing trader using these techniques is better off taking most of the position off when the market is going the right way.

If you are trading multiple futures contracts or several hundred shares of stock, you can take advantage of the ability to scale out.  Scale out means to take some profits a little at a time.  This both puts “some money in the bank”, and reduces your $ risk on the remainder, due to the smaller position size.  If you do this, you can then leave a trailing stop on no more than 25% to 33% of your position – just in case it is one of those rare times where the market decides to really trend.

In using exits with both stops and profit objectives, experience will be your best teacher.  Markets never repeat exactly, so there are no hard and fast rules that are going to work all of the time.  With experience though, you will get a better feel for how to handle each situation on its own merits.

Do not try to follow too many markets.  How many you choose depends on how much time you have.  I can spend less then 5 minutes sometimes looking at a market before it becomes apparent there is not much of interest there.  On the other hand, I can spend 30 minutes to an hour exploring various techniques on a market that does spark my interest.  I would guess for the most end-of-day traders 2 to 4 markets is a good number.  You will get to know these few markets a lot more intimately, see their repetitive idiosyncrasies, and that will help your trading.

That sense of being “in tune” with your markets can really help your bottom line.