Stop Loss Tips & Tricks.

Stop Loss Tips & Tricks. By The PitMaster

This summary of stop loss techniques are my adaptations of industry standard recommendations.  They work well for me, try them along with your own paper trading strategies then adapt and expand them to fit your own style. –The PitMaster

To understand the where's and why's of stop loss placement, we must first understand market movement.  A brief explanation of this is called Swing Movement. It's been better popularized as the Fibonacci Retracements.
	A Swing is a movement from low to high, or high to low.For example, a 123 bottom consists of 4 swings. The move which ends at the #1 point low is a down swing. The rally up to the #2 point is an upward swing, while the swing down to the #3 point is a swing, and the rally which penetrates the #2 point is the 4th and final swing. In other words each rally or break in a pattern is a swing.
Basically the definition of a Bull Market is a market which makes "higher highs" and "higher lows." A Bear Market is a market which makes "lower highs" and "lower lows."What is a 123 Bottom, but a market which makes higher lows (#3 point is higher than the #1 point)? When the #2 point is penetrated, the market is making higher highs. This pattern is the very definition of a Bear Market turning to a Bull Market, while the 123 Top is the very definition of a Bull Market turning to a Bear Market. Each extreme of a swing, should act as support or resistance. When I examine charts, I look at the swings and look for markets which are making higher highs and higher lows to buy, while I look for markets which are making lower highs and lower lows to sell. After the trend has been defined, one must figure out where the trend would change. For a Bull Market it would be the last swing low (point #1 on the above chart). For a Bear Market it would be the last swing high. In other words, the basic rule is to trade in the direction of the trend and risk the trade to where the trend is no longer valid, as a maximum stop loss.

When the #2 point is penetrated, the market is making lower lows. This pattern is the very definition of a Bull Market turning to a Bear Market. Therefore, we place our stop order to enter the market on a break out or any penetration of the #2 point.  If the market then turns around and breaks back past the #3 point, it would have just broke the Bear Market rule. (The market would no longer be making lower highs.) Therefore, often times I recommend placing your stop loss order more conservatively, just behind the #3 point as opposed to waiting for the market to break the #1 point. Each extreme of a swing, should act as support or resistance. What's good for a 123 Top formation, is also good for a 123 Bottom formation.
Narrow sideways channels are one of the easiest formations to identify and to profit from.  When the market breaks out of the channel one way or the other, we simply place our stop loss behind the channel's resistance. Sometimes, when the channel is very wide, we may not want to risk that much money, therefore consider placing your stop loss at about the 50% level. Again, each extreme of a swing, should act as support or resistance.
This is one of my favorite formations. When the market starts forming a Triangle, I get all excited. Basically, the same rules apply for this formation as for a narrow sideways channel. Watch for triangles, the break out is usually very dramatic.
Notice on this formation how close behind the entry point I trail my stop.  Watch for Wedges, the break-outs are also usually very dramatic.
The PitMaster's Stop Loss Rule-Of-Thumb.Where the chart formation is taking place within relationship to the short and long term trend is a very important consideration in how aggressive you might want to be when placing your stop loss orders. Also, is the formation taking place within a Bear move, or a Bull move? It's important to know this, because as you well know, "The Trend Is Your Friend." Even though each indicator above may be an indication in reversal of direction, you also want to remember the old adage, "A body (market) in motion tends to stay in motion." The same rules apply when the markets are in reverse. Place stop loss at the entry point if the market breaks DOWN, and consider taking profits quickly.	Figure #1: If the market breaks DOWN, place your stop loss at the industry standard point or consider a more conservative 50% placement (Depending on the width of the channel or triangle.)Place stop loss at the entry point if the market breaks UP, and consider taking profits quickly. Figure #2: Place stop loss at the industry standard or more conservative 50% retracement on break down OR up. (Depending on the width of the channel or triangle.) Figure #3: If the market breaks UP, place your stop loss at the industry standard point or consider a more conservative 50% placement (Depending on the width of the channel or triangle.)

Hypothetical results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program, in spite of trading losses, are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.