Always set a stop loss order when day or swing trading. While we form expectations and make trading decisions based on what we believe will happen using our tested method, the fact is, at any moment price can do anything. Not having a stop loss in place leaves us susceptible to a very large loss. Stop losses control risk, but need to be placed at a price that still allows the market to move toward the target or in our expected direction. Once set, a stop loss can also be managed as the trade progresses.
What Are Stop Loss Orders
The stop loss is an order placed at the same time a trade is opened, to control the maximum loss of that trade.
A stop loss, when triggered (the price touches the stop loss price), closes out the position at any price available. This can result in slippage, meaning the loss–even with a stop loss order–may be larger than anticipated. While this is a drawback, I have typically found that I would have taken an even larger loss had my stop loss not been there. Overall, slippage has never been an issue for me and I have been trading since 2005.
It is important to place a stop loss so you have a good idea how much a trade could lose. While no one wants to take a trade thinking they will lose, losses are a constant in trading, and losses must be controlled in order to succeed.
Setting a stop loss also allows us to determine our position size. If we don’t set a stop loss it’s very hard to choose a position size that is in alignment with the account size.
I choose not to risk more than 1% of my capital on a single swing trade or day trade. Even following these guidelines it is possible to make a substantial amount of money (see: How Much Money Can I Make as a Day Trader). Risking up to 2% per trade is acceptable once you have a well-established system that you know provides consistently favorable results.
Stop Losses and Position Size
Let’s say you have a $10,000 trading account. If you risk 1% of the account you can risk $100 on a trade. Without a stop loss “$100” means nothing. You need to define your stop loss and then calculate your position size in order to define how that $100 will be risked.
Let’s say you decided to buy 100 shares of stock at $50 and place a stop loss at $49 (risking $1 per share). If the stop loss is hit then you have lost $100. Therefore, the ideal position for your stop and risk management protocol is 100 shares. But in order to calculate that you had to set the stop loss.
Notice that risking $100 doesn’t mean we only buy $100 worth of stock. In this case, we are only risking $100 but are in fact buy $5,000 worth of stock ($50 x 100 shares).
This example greatly simplifies things though. A stop loss should not be placed at an arbitrary level. It should be at a price level, that if hit, shows you were wrong about the trade (at least for now).
Where to a Set Stop Loss When Trading
I use one method for setting a stop loss, and it can be applied to almost every strategy I trade. Having a stop loss method you can use no matter what market or time frame you are trading greatly simplifies things.
My preferred stop loss method is a fixed stop loss. It may vary slightly based on what market I am trading or what time frame, but overall, every single day and every single trade I know that my stop loss is going to be pretty close to this fixed amount. This is covered in several strategies in my Forex Strategies Guide eBook and also my Stock Market Swing Trading Video Course. This method allows me to put my stop loss close to my entry price, but still far enough away that it won’t get hit if my analysis is correct.
Below we will look at stop loss examples in the forex, futures, and stock markets.
When I swing trade major forex pairs–for me, this is trading off 1-hour and/or 4-hour charts–I typically enter on a breakout of a small consolidation. My stop loss is placed 5 pips outside the opposite side of the consolidation from the entry. The chart below shows an example of this. The AUDUSD formed a choppy consolidation right along a descending trendline. This signaled that I wanted to go short when the price started to drop again. I took a short (middle blue line) and placed a stop loss 5 pips above the consolidation high (upper yellow line marked “stop”).
In the forex market we have to account for the spread on our stop loss when we are in a short trade, so in this case, my stop loss would actually be placed 5 pips, plus the average spread, above the consolidation high…or about 6 pips above the consolidation high. If you take a long trade, in the forex market, placing a stop loss 5 pips below the consolidation (or whatever price structure you are using to enter) is often sufficient.
The same method applies to day trading forex, except my stop loss will go 1 pip (plus the spread when applicable) outside the consolidation. This makes it easy to place stop loss orders quickly, and not have to second-guess where you should be putting it on every trade.
This stop loss method is designed for the strategies I trade. It may not work for all strategies; if you trade a different strategy you will need to calibrate your stop loss so that it’s effective for your method. Effective means it gets you out of trades that would have resulted in even bigger losses, but still allows you to profit when the price moves favorably.
Inevitably, sometimes you will get stopped out only to watch the price immediately move back in your expected direction. Welcome to trading. This happens. If your profits are bigger than your loses and/or you win more trades than you lose, you will still come out ahead over many trades. Letting a loss grow is a much bigger issue than getting stopped out.
When I day trade ES futures I use a similar approach. Every day, every trade, my stop loss is the same. It is placed three ticks above/below the consolidation I am selling/buying in. Since I always try to buy within one tick of a consolidation low or sell within one tick of a consolidation high, my stop loss is always 4 or 5 ticks on every trade. This allows for me to rapidly place orders. My initial target goes 8 ticks away from my entry point when trading this market.
If we were swing trading ES futures, and buying or selling on a consolidation breakout, then we would place a stop loss about 1 to 2 points outside the opposite side of the consolidation from the entry.
For day trading stocks, I use a bit of subjectivity because stocks vary wildly in terms of price and volatility. For most stocks I place my stop loss 2 to 3 cents outside the consolidation I am entering on. If it is a very volatile stock, or a high-priced stock, then I will expand this “buffer” based on how much the stock moves. Quickly look at prior trading opportunities within the stock to help gauge how far your stop loss should be outside the consolidation.
For swing trading daily stock charts, my default is to place a stop loss 5 cents outside the consolidation. This is effective for many stocks, but often needs to be expanded if trading volatile or high-priced stocks. This is because 5 cents is a decent sized move for a $5 or $10 stock, but is absolutely nothing in a $200 stock.
In the daily chart swing trading example below, the stock is fairly volatile. While using a 5 cent stop loss outside the consolidation or below the most recent low would have worked, I actually opted to place a stop loss 20 cents below the most recent swing low. The chart shows two potential entry points based on the strategies I use, as the market sometimes provides more than one opportunity to get into a trade.
Where to Set a Stop Loss – Stop Loss Management
New traders should allow the market to hit their original stop loss or target: “set it and forget it.” Actively managing trades complicates the trading process and can induce a lot of emotion which new traders may not have the skill set to deal with. That said, some basic stop loss management is acceptable, such as reducing risk once a trade is closing in on the profit target.
Only move a stop loss to reduce risk or lock in profits. Never move a stop loss to accommodate a growing loss hoping it will turn around if you give it more room!
While I often just get out of trades at my stop loss or target, I also have some guidelines that allow me to alter my stop loss or target during a trade, or alter my exit plan.
- If day trading, I get out of a trade about 2 minutes before a major economic news announcement.
- If swing trading, I get out of a trade if the current price is close to my stop loss or target and a major economic news announcement is coming out soon.
- Stop loss may be moved to near breakeven once a trade is 50% of the way to the target.
- Stop loss may be moved in further, guaranteeing a profit, once the price moves 75% of the way to the target.
- At the outset of some trades, I determine that I will use a trailing stop loss. As the price moves favorably, I move my stop loss to lock in profit in alignment with the trailing stop loss strategy.
- If I happen to be watching a trade and the price is very close to the target, but hasn’t hit the target, I manually get out immediately.
That’s it. Keep it simple.
Final Word on Using Stop Loss Orders
With day trading and swing trading, control risk. Use a stop loss! A stop loss helps determine our position size. My method is to place a stop loss at the point closest to my entry point that won’t get triggered if my analysis and expectation is correct. This typically puts my stop loss just outside the opposite side of a consolidation from my entry. When I am wrong, I am wrong small.
Letting the price hit your stop loss or target is recommended when you are starting out; don’t intervene in your trades while they underway. As you improve, and you have the discipline to let the price hit your stop loss or target, then consider managing your stop loss while in a trade to potentially improve performance. Actively managing won’t always result in greater profits though. If letting the price hit your stop loss and target works for you, don’t mess with it.
For a complete trading method, check out my Forex Strategies Guide for Day and Swing Traders. It leads you step-by-step through a process for becoming a successful trader, as well as providing strategies and trading plans you can use to build your capital in a risk-controlled manner. The eBook covers forex basics to advanced tactics.
By Cory Mitchell, CMT
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