Risk management is an important concept in daily trading. It is simply the process by which a trader operates Maximize they earnings While reduce their losses.
One of the most common risk management strategies is to have a file stop loss or trailing stop loss. In this article, we will explain what a stop loss is and how to prevent it.
What is a stop loss?
Stop Loss is a tool that is provided by most of the online brokers, platforms and exchanges such as Coinbase, DTTW, Robinhood, Schwab and others. that it risk management tool who – which Trade stops automatically Once you reach a certain level.
For example, suppose you executed a sell trade at $137 as shown below. In this case, your goal is to make money as the stock continues to decline.
As such, your profit target could be $133. At the same time, you can place a stop loss at $141 to protect your trade if it goes in the opposite direction.
When the stop loss order is executed, you will lose but It will protect you from a greater loss If the trade goes against you.
Stop Loss vs Take Profit
The opposite of stop loss is take profit. a Profit taking is a tool The deal will stop automatically when it reaches a certain profit limit. For example, in the example above, the take profit from the trade would be at $133.
As a result, if the stock falls to this level, it will be stopped at profit. The benefit of the take profit is that it closes out when it hits the target. Most traders set their trades, set stop loss and take profit, and then wait for their trades to develop.
Types of stop loss
there Two main types of stop loss in trading. First, there is a file Basic stop lossthat fixed at a certain level. A good example of this is the one we described above. You open the trade and then set the stop loss at the specified location.
Secondly, there is a graduated stop loss order. This is a stop loss that is not fixed in a particular place. Instead of that moves with the original. This stop loss solves one of the biggest challenges of a fixed stop loss. Where is the challenge? The asset becomes profitable and then makes a sudden turn It turns red.
In this case, if it triggers a stop loss, your initial profit will be wiped out and your trade will be closed with a loss.
Trailing stop solves this challenge by ensuring that you get the challenge I grabbed these profits. As such, if it is triggered, the loss will be equivalent to what you had planned.
How to do stop placement effectively
There is a common question among many traders about Best Strategies to Place a Stop Loss. These traders ask these questions because they are often stopped out. There are many wise strategies to use when placing a stop loss order.
Consider the risk-reward ratio
First, always keep in mind the risk-reward ratio. This is an important percentage Determines how much money you risk compared to what you get.
For example, you can decide to have a balanced 1:1 ratio. In this case, for every $50 you intend to lose, you can plan to gain $50. In most cases, it is recommended to make sure that you are Don’t risk more than 5% of your total account value.
Avoid this trigger stop!
secondly, Do not place your stop loss too close to the opening price. This is a common reason why most traders see their trading stopped.
Ideally, no matter how accurate you are, Trade will always show some volatility well before it develops. As such, if you place a stop loss order too close, it will increase the likelihood of it being stopped out.
Analyze more than one time frame
Third, it is important to Look at key support and resistance levels When placing a stop loss order. One of the best ways is Perform multi-timeframe analysis. This is a process where you perform a comprehensive analysis based on multiple timeframes.
For example, if you are a 1 minute trader, you can start your analysis in 15 minutes followed by 5 minutes and then 1 minute. The benefit of doing so is that it will Help you find the best levels To place this stop loss.
Analysis from multiple angles
Finally, you should always Do a lot of analysis before you do your stop position. In this, we recommend that you do Technical Analysis Based on indicators such as moving averages and the relative strength index (RSI).
This should be accompanied by price movement Analysis that includes Looking at chart and candlestick patterns. Finally, you should do Fundamental Analysiswhere it aims to take a look at the main topics in the market.
Mistakes to avoid when using a stop loss
there Three major mistakes You should always avoid them when placing a stop loss on a trade. Some of these errors are serious because they can cost you a lot of money, but they are not the only ones. Others can make the stop loss ineffective, invalidating all the work done in the analysis and setup.
First, you must never a place year or subsequent stop loss blind. This means that you must Always do your analysis When placing a stop loss. There must be a reason to place the stop loss at the specified level.
Set the off manually
Second, you must Avoid messing with your stop loss. This is one of the most common mistakes people make. It’s common changing stop loss level When the trade is in the losing zone.
For example, if the stop loss is at $10 and the stock drops to $10.5, you can extend the instrument to $9 to prevent the stop. This is a mistake. Alternatively, if the trade is taking a loss, let it stop.
very narrow range
Third, as we explained above, you must Never place your stop loss too close to the opening price. If you do, it will increase the likelihood of your trading being stopped out.
What does this mean? First, your trade will be stopped immediately, preventing you from achieving higher returns. Then you will have wasted unnecessary time analyzing the asset and setting your stop loss.
In this article, we looked at the importance of having a stop loss when trading. We’ve also looked at the difference between a standard stop loss and a trace (and why you should use the latter).
Most importantly, we have outlined the most common mistakes we see when people set up a stop loss. And we don’t want to make mistakes in creating one of the most important risk management tools, do we?