I had written a previous article about whether you should use stop losses. There should never be a scenario where you don't use a stop loss if you don't want to blow up your trading account.
What happens if you are in a trade and you wish to move your stop loss? This is a very difficult topic and one where the answer lies within yourself. The reality is that there are no rules and you will need to develop your own methodology, ideally one that suits your trading psychology. We will explore in this article some of the scenarios and options available.
The possible scenarios for what to with a stop loss, after entering a trade are:
adjust the stop loss to break even, after a certain trigger event
never move stop loss and either be crashed out of trade or take your profits at targets
trail the stop loss as the trade is running to continue locking in profits
differing strategy for each trade
Adjust stop loss to break even
Some would consider it de-risking the trade to move the stop loss to break even after the trade goes in your favour. It's not that simple, there are a lot of circumstances to consider before such an action is taken.
Price action is fundamentally unpredictable and by closing the breathing room space between where your stop loss is and where price action is currently trading can be devastating if the price is volatile. I have personally moved my stop loss in the early days especially. I was desperate to not have a loss.
The opportunity cost is lost profits if the trade goes well. The problem with this technique of moving the stop loss to break even too early is that it sets the trader up for a magnificent meltdown if the price takes out that stop loss for break even and then absolutely rips back in the direction the trade was taken in. This is excessively painful if you would still have been in the trade if you had not moved the stop loss from its original location.
There are so many examples of this in trading, be it Indices, commodities, equities and each and every time frame. You really have to set some rules what to do with stop losses. Look back at your trades to understand from your journalling to understand how you are currently moving your stop losses and whether it is a problem.
Never move the stop loss
This is the easiest to implement technically. By never moving it and waiting to be stopped out or taking profits you can remove the emotional agony of battling the decision of whether you should move your stop loss. Don't underestimate how difficult it can be to sit on your hands. It took me a lot of discipline and effort.
There will be a lot of trades where this strategy will lose you money or lose you more money than you would have because you didn't move your stop to break even. If you have the strength of commitment to your strategy in this area, at least you will be sure that when bigger moves happen, and you are on the right side of the move, you will be more likely to capture the largest part of the move.
See an example below of a breakout trade on the FTSE index on the daily chart.
This would have been a great breakout trade, IF the trade was managed correctly. A proper way to have traded this would have been an entry towards the end of the daily candle with a stop loss placed below the breakout candle. This candle had smashed through all resistance to the left and was a high probability set up.
After a few days the price continues to gradually move up in a relatively tight range, as the market participants fight between who will be dominant, the bears or bulls. At this point the trader who is not going to move their stop loss just doesn't care and is indifferent to the price action at this point.
However, a scary pull back with a large bearish elephant candle is then formed. Had any trader decided to move their trade to break even they would likely have been stopped out. If they were stopped out then they would have missed a surge in price action to the upside. Any trader who had just simply held would have then been left with a much better problem; where to take my profits and how much?
If a trader does manage to survive a sizeable pullback they can then consider moving that stop loss. One way to do this is to move to a slightly lower time frame to get a more accurate picture as to how the price action on the higher time frames you are trading are forming. See above for the same FTSE chart but this time on the 4 hour chart.
After the pull back in this instance, you see that price shoots back up to the area where it broke down from previously. At the point where there is consolidation, at the previous resistance a trader would, if they want to consider it moving their stop loss to this zone. This would be the safe play at this point, along with taking some profits. Patience and composure are key to maximising profits for the trades where they move in your favour.
Trailing the stop loss
Sometimes the price action will not have aggressive pull backs and a more methodical movement of the stop loss would work well. See this example of a short trade on Gold 5 minute chart.
In this example the price dramatically crashes through support. The price action has small pull backs. You can see by the blue lines that these would be potential places to move any stop loss to on the way down. Each pivot high would be a low risk play, particularly in a strong move. There would have to be a breakdown from each lower high pivot.
This is a much more measured approach to controlling your stop loss but requires a very disciplined mind. The other option available is an automatic trailing stop. Most trading platforms allow you to run a trailing stop, whereby the stop moves along with the price action.
Traders can use moving averages to determine the movement of stop losses. If using moving averages (say 20 period moving average) you would move your stop loss to be just under that moving average for a long position and just above it for a short position. If the price is trending strongly the trader will have a good chance of capturing the price action movement but the trader runs the risk of whipsaw movements through the moving average, stopping the trader out, only to then continue in the trend direction. In the gold chart shown above, if you apply moving averages the full move wouldn't have been captured as the trader would have received false signals that the price was reversing. It is a lot of work to experiment and make extremely technical which period moving average to apply.
As explained earlier, there are no right or wrong answers, you have to decide what is the best suited to your trading psychology. Can you stomach volatility and pull backs and brave enough to take more risk? Or, do you prefer to tight with the use of the stop loss and potentially miss gains. Which for you is the most painful?
Trade Clearly!
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