Stop loss placement is perhaps the most overlooked and misunderstood part of the trade puzzle …
Aside from the special trading strategy you use to navigate and trade in the markets, "where you place your stop loss" is arguably the most important aspect of any trade you make.
One of the cornerstones of my trading approach that I am introducing to my members is the importance of using wide stop losses. Many traders are naturally attracted and try to set a tight stop loss on their trades. There are several reasons why traders do this, but they are all the result of a lack of understanding of important aspects of trading such as position sizes, risk-reward ratios, proper stop-loss placement, and the use of wider stops.
This lesson will dispel some of the most common myths and misunderstandings about placing stop losses and help you understand the importance of planning your stop loss placement correctly and not being emotional when placing your stops, e.g. . Avoid placing them too narrow and in a price range where they are likely to be hit.
First a note about the position size …
I am surprised at how many people still email me every day because they think they need to use narrower stop losses, because they have a small account and a too wide stop will cost them too much to trade. This notion is based on the (wrong) belief that a tighter stop loss somehow lowers the risk of a trade or (just as wrong) increases the chances of making money as they can increase their position.
90% of the new traders I'm talking about still think that a smaller stop-loss distance means less risk and that a larger stop-loss distance means they risk more. However, these beliefs are simply not true and for any experienced trader who understands the dimensioning of the trading position, it is obvious that the contract size (number of lots traded) determines the risk per trade, not the stop-loss distance itself. The stop-loss distance is not nearly as important as the position size with which you trade. It is the position size (lot size) that determines how much MONEY is risked per trade!
The money you risk for a particular trade will increase or decrease as you adjust the number of lots traded. In the Metatrader platform I use, the position size is referred to as "volume", for example. The larger the volume, the more lots and therefore more money you risk per trade. If you want to reduce your risk, reduce the number of lots traded. The stop-loss distance is only half of what determines how much you (your risk) could lose on a particular trade. If you adjust your stop loss distance but not your position size, you are making a serious mistake!
To put this in perspective, a trader can have a stop loss of 60 pip or a stop loss of 120 pip and still risk exactly the same amount of money. He only has to adjust the number of contracts with which he trades.
Trade 1 – EURUSD trade. Trading 120 pip stop losses and 1 mini lot is risking $ 120 USD.
Trade 2 – EURUSD trade. 60 pip stop losses and 2 traded mini lots are associated with a risk of $ 120.
You see, we have 2 different stop loss distances and 2 different lot sizes, but the same dollar risk.
It is also important to note that wider stops do not decrease our risk reward because the risk reward is relative. If you have a wider stop, you need a wider goal / reward. We can still make great trades 2 to 1 and 3 to 1 or higher with daily charts and wider stops. We can also use pyramids to increase the risk-reward return.
Why wider stops?
Now that we know that we can use larger stop losses for each account, the question arises as to why I use wider stop losses and how you can implement them in your own trading.
Give the market space to move …
How many times have you been right about a market direction, your trading signal was correct, but you still lost money somehow? Very, very frustrating. Here's why this keeps happening to you. Your stop loss is too tight!
The markets sometimes move irregularly, sometimes with high volatility without notice. As a trader, it is part of your duty to include this in your decision-making process when deciding where you want to place your stop losses. You cannot just place your stop loss on each trade at a fixed interval and hope for the best.that will not work and it is not a strategy.
You have to leave room for the normal "vibrations" of the market every day. There is something like the Average True Range (ATR) of a market that shows you the average daily range over a period of time. This can help you identify the recent and likely current volatility in the market. This is something you need to know if you want to find out where to place your stop losses.
If the EURUSD moves 1% or more (over 100 pips) on some days, why would you place a 50 pip stop loss? It doesn't make sense, does it? But every day traders do just that. Of course, there are other factors to consider, such as: B. the timeframe traded and the price action setup you traded as well as the surrounding market structure, which I will go into in detail in my pro-trading course.
Below we see two pictures, the first is the EURUSD daily chart, which shows an ATR of over 100 and close to 100 for many days. The second is crude oil, which also has a large daily ATR (over $ 2 for many days). Traders who are not even aware of the ATR of the market they are trading in have a big disadvantage when it comes to placing their stop losses. At the very least, you want your stop loss to be greater than the 14-day ATR:
Crude Oil ATR: Crude oil is measured in dollars and cents, but an ATR above $ 2 a day or even $ 1.75 is relatively high. Rest assured, if you don't place your stops outside of this ATR, you will burn yourself.
With wider stops, trades can be played longer
As we know, large trades can take days or weeks to unfold if I trade price promotions based on the end-of-day approach I use. With a 30- to 50-pip stop, you simply won't get a 200-300 point move on EURUSD. Most of the time, you were stopped long before the real market stop.
Case and point: The following two pictures show the same EURUSD end bar signal, but with different stop-loss positions.
The first picture below shows a narrower stop loss and the second picture below shows a wider stop loss. If you look at this example, it's pretty clear why you need wider stops.
Note that the stop loss was placed 20 to 30 pips below the support level in the 1.1528 range in the scenario below. This is often a good technique:
Next, let's look at an example on the daily crude oil chart below. This time we have a very obvious buy signal for double pencils that was recently formed in the timeframe of the daily chart. Note that if you had put your stop directly under the pin bar, as many traders like to do, you would have been stopped for loss just before the market rose without you being on board.
If you had placed your stop loss about 50 points below the lows of these pins, you would not only stay in the trade, but would also have been a fool if you hadn't made a nice profit after the price went up again.
Note: Regardless of which entry you use, a market entry or a 50% tweak entry, a larger stop loss will dramatically change the outcome of trading even with more conservative 50% tweak entries. The goal is to stay in the market until it becomes clear that you are wrong, and not just to be shaken by natural daily price fluctuations. Give the market the space it needs to breathe!
I don't swap a day, so wider stops are essential
If you have followed me for a long time, you know that I do not do any day trading. In my view, daily trading is just natural market gambling that occurs every day, and I'm a trader, not a player. Therefore, it is important that I use a wider stop loss that does not result in me being involved in the short-term intraday noise of the market.
It's an interesting "coincidence" (not really a coincidence), of course day traders use very tight / small stops (some don't use one!) And the statistics show that day traders usually lose money and do worse than longer-term position traders. Is it just a coincidence that people who use narrow stop losses tend to lose more money than those who use wider stops and keep traders longer? I do not think so.
Longer-term trades require larger stop losses. If we know the EURUSD is moving a few percentage points a week (e.g. 200 to 300 pips) and we are looking at a price action that could bring us a profit target of 200 to 300 pips, then it makes sense that you this will need a broad stop loss to stay in this trade.
Remember that the performance of timeframe charts is immense. Yes, you have to wait longer for trades to run in higher timeframes. However, the downside is that you get more accurate signals and it is much easier to name a market the higher the time frame. So trading becomes less a game of chance and more a skill, the longer the time frame. For many reasons the timeframe of the daily chart is my favorite, it is a happy medium.
Lifestyle and less stress
Perhaps the greatest benefit for YOU is that using longer periods of time reduces stress and improves your lifestyle. You can place and forget trades with larger stop losses. Wider stops are what my end-of-day trading approach promotes, and it means you don't have to sit agonizingly over every tick of the market.
This type of trading also gives you more time to learn and focus on finding good trades and identifying trends and price action patterns by reading the footprint on the chart. the stuff that matters!
If you want to move away from your trades and relax while the market is doing the “heavy lifting”, all you have to do is: Use larger stop losses and adjust your position size to maintain the desired dollar risk per trade. That's it!
Let me ask you something …
Do you know why most retailers fail in the long run? Yes, because they lose too much money. But why are they losing too much money?
The two main reasons why so many traders lose money and blow up their accounts are: Trade too much (over trade) and use stop losses that are too tight (leave no room for trade).
A funny thing happens when you start making tight stops, you stop more often! Seems obvious, doesn't it? But every day thousands, probably millions, of otherwise very intelligent traders do something really unintelligent. You put a tiny little stop loss on a perfect trade setup. They do this because they don't understand the position size or because they're greedy either way, they're doomed and just another statistic.
Don't be like them.
Be patient. Be ready to make a broader stop, even if that means you're running a trade for a few weeks. Ask yourself which is better: place 20 trades with tight stops and lose on most of them, or place 2 trades with wide stops, win big on one and take a predefined 1R loss on the other? I promise it is the latter, not the former.
Read this lesson again carefully. This is possibly the most important trading hour you have ever learned. Combine the concepts taught here today with the trading techniques and pricing strategies that I teach in my trading courses and the daily guidance provided by my members' newsletter, and you yourself have a fairly effective long-term trading strategy that, if followed, is a very good opportunity To bring you closer to constant success in the markets.
What do you think about this lesson? Please leave your comments and feedback below!
If you have any questions, please send me an email.