By VIKRAM
If you have been in trading business for a couple of years or even for few months, ask yourself when you made your biggest loss in trading…. I am sure your answer would be when you traded without SL or you placed your SL and then you moved it further away or removed it completely thinking that stock will reverse and you will exit at break even….but instead of breakeven you ended up breaking the bank.
Stop loss is one among the most controversially discussed concept in trading and there are a lot of misunderstandings about stop loss orders. To explain it in simple terms, Stop-Loss is nothing but a price which you specified to your broker that if it hits that price then he can just square off your position with a small loss so that “you will live to fight for another day”
When I was new to trading, I didn’t hear about SL and when I started hearing about SL by analysts screaming on TV channels like this is the target and this is the Stop Loss. I would feel like, how absurd it is, how can you talk about loss even before taking the trade, after all, we come to the stock market to earn a profit, not to make a loss, right?
Even I heard many traders complaining that when they place Stop Loss there brokers come to know and purposefully hit their SL, so, many traders think that best option is to trade without SL, and finally they blow up their account one day, if you repeatedly see your SL getting hit and then price reverses into your original direction, it’s because you placed your SL at a place where other traders also placed, it’s very easy to spot retails traders SL in trading and big players and professionals know where the stops will be.
It’s not that big players are against you or they don’t like retails traders that they take your SL, it’s just that they need liquidity for their big orders to get filled, that is the reason when SL hits you will see unidirectional moves in one side, especially in late afternoons
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“If you can’t take a small small loss, sooner or later you will take the mother of all losses”
–Ed Seykota
Now let’s see some of the common mistakes in placing your Stop Loss,
Not placing your Stop Loss.
This can be considered as the biggest crime in trading, not placing you stop loss, it may happen that sometimes you get lucky that you didn’t place your SL, price came to the place where you were supposed to keep your SL and then reversed in the original direction giving you good profit.
You felt so proud that had you kept your SL your trade would have been a loss, you feel that you acted smart by not placing SL and you converted that trade in to profit, but sooner than later a day will come where price will not reverse and keep going down and since you have no SL, you will end up blowing your account.
When it comes to SL it reminds me below quote from legendary trader Ed Seykota “If you can’t take a small small loss, sooner or later you will take the mother of all losses.”
Widening the SL (Stop Loss)
This is another crime in trading. It’s a human tendency not to take the loss, if not profit then at least to stay at breakeven, another reason could be ego, trying to prove that I am right, my analysis is right and the market is wrong.
Many traders initially keep SL and when they see price approaching it they will move it away and again further away and eventually they give up when they see MTM loss is swelling up.
So if you are facing this problem, once you see the price coming near your SL just shut down the system or get away from that place and come back only after some time (say after 30-45 min) and see whether market took your SL or it reversed back to the original position.
You may or may not able to save your SL but you will definitely save your capital by following this method.
Placing SL too quickly to breakeven
Though with this method you can save yourself from a small loss but you will miss an opportunity to make a big profit if price goes in your direction.
Why traders move their SL to breakeven? because of fear,they want risk free trade.
If you want to be defensive and want risk free trade then place SL at breakeven only once price moved at least 1% away from your entry price, once it moved 2% book half the position and trail your SL at 1.5%
This is most commonly followed by many traders who trade in multiple lots but I am not a believer in this, I go all for once and exit at once, means I neither scale in nor scale out, I see Risk-Reward in my every trade.
I look for 1:2 RR, if I see some resistance than I even book profit at 1:1.5.
Very rarely it happens that I book profit at lesser than 1:1(some times on expiry days)
Keeping mental loss rather than system stop loss.
This is another mistake many traders do, having a mental stop loss fearing that keeping SL will be hunted.
If you keep SL at random places obviously it gets hit, rather keep it in a place where it is not likely to hit.
Now the question is where exactly one has to keep SL or where not to keep SL so that it doesn’t get hit?
The right method of keeping a SL is…
Placing Stop Loss based on ATR (Average True Range)
This is my favourite stop loss method if I am taking a trade especially in mid afternoon when volatility is less, ATR will tell you the average range of the price on the timeframe you are trading, ATR is different on the different time frame,
If you are trading bank Nifty on 5 min time frame then ATR could be 50 and if you are trading on 1-hour time frame then ATR could be 150 or 200.
ATR will tell me range or volatility at that current moment which helps me to place my stop loss, so my method is, if I am trading Bank Nifty futures on 5 min time frame and ATR is 50 then my stop loss is 50 points plus 10 points buffer, total 60 points.
If I am trading Bank Nifty ATM options then my Stop Loss is half of ATR, in this case, 25 plus 10 points buffer, total 35 points.
This method helped me many times in saving my Stop loss, one more reason it works for me because I take trade exactly at the support, I don’t take trade in FOMO (fear of missing out)
That means if I see a strong support, say PDL and weekly pivot of BN at 30200, I patiently wait till price comes to exact or near to 30200 and then punch my buy order, so my SL will hit only if I am wrong, it very rarely happens that my SL get hits and then market goes in my expected direction.
As per my experience, stop loss hunting happens very rarely in the opening, so I don’t follow ATR during that period, I have seen price respects support and resistance more often during these periods, but knowing ATR will always give me an idea how is the volatility at the opening, if I see volatility high(above 50-60 on 5 min time frame) at the opening I place stop loss with extra buffer with fewer lots, if ATR is normal (40-50) I trade with normal quantity with fixed SL which is explained above.
In all charts I post, you see an indicator at the bottom that is my ATR indicator.
Avoid placing SL just below support or just above resistance
This is most common in trading known as stop-loss hunting, many traders face this at the beginning of their trading career, when they see strong support and they place buy order and SL will be right below that support without any room, because they read it somewhere one has to buy at support and SL just below it..
But when they see price hits their SL and start going up in their expected direction they start wondering what went wrong, they start cursing their broker thinking broker knew their SL and it was purposefully hit.
It was not your broker but big institute and big players who have the capability to move the market knows your SL, with their experience they can easily judge where all retail traders kept their stop loss.
It is not that big players want to throw you out of the market or they get a kind satisfaction when your SL hits and you lose your money, it’s just that to move the market in their direction they want liquidity and they get that liquidity by taking retailers SL.
[bctt tweet="Where to keep SL in trading."]
So how to avoid getting trapped and save SL hunting?
As I said earlier I wait for the trade to come exactly at support or resistance price, I don’t buy 50-60 points before support or resistance fearing that if I wait I will miss that trade.
True, sometimes I miss some good trades, but at the end of the day I save my capital by saving myself from SL hunting, and whenever it comes to exact support or resistance level I go with huge lots and also I get extra room to place my SL and eventually good Risk Reward ratio.
SL based on moving average
This is my favourite method when a stock or index is in clear uptrend or downtrend mode.
This method works as a SL but same time works in riding big winners.
Whenever a stock or index in trending mode, trending up or down, especially at opening, I plot both 8 and 20 EMA on my chart, I buy when it retraces back to 8 EMA and place SL just below it.
If I see that a stock or index moving in a clear uptrend and I missed to ride it, especially in mid-afternoon, I patiently wait for it to retrace back to 20 EMA and once it touches 20 EMA I am long with SL just below 20 EMA.
This simple technique helped me to ride many winners with small stop losses. I have seen if stock opened gap up on some good news it keeps flying and one can ride this trend until the candle closes below 8 EMA.
20 EMA works very well in mid afternoon when you see the stock is trending on some good news and when it hits 20 EMA one can enter with an SL just below 20 EMA and most of the time such stocks close at almost high of the day.
This works very well on stocks because every day one or other stock is in trending mode.
I used to follow this method when I was trading stocks but since now I have moved to Index I don’t use this method until and unless the index is in trending mode.
CONCLUSION
One needs to treat stop loss like an expense in your business, if you had any other business you would have expenses like office rent, employee salary, raw materials cost etc, but in trading, you have no costs like these other than brokerage (which is very small) and taxes
So make peace with your stop loss, determine your stop loss even before taking the trade and if it hits, accept it, respect risk, respect your stop loss.
Because to win in this game of trading first you need to survive to fight another day.
[bctt tweet="Where to keep SL in trading."]
Well written !! Thanks.
Thanks
Presently I am concentrating only on Nifty futures and trading on Call and Put. with price action, Pivots and VWAP. Hitting of SL and then reversing is one of the area for me to improve.
Good article on SL. Very much helpful for me. Thank You
Thanks Williams.
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