Stop Loss Strategies Continued...

Picking up from last week, we looked at the background information that could affect the efficiency of a stop loss in the market. In this article we will focus on some well known and high priced US equities with recent ABC trades and how our stop losses can impact on profitability.

It is important to note before we look at the charts that when we trade a market we place our stop loss orders based on the physical market, in this case it would be the stock itself. Most CFD platforms, for example, allow you to run orders based on the CFD price or the stock (physical) price. The benefits of running it over the physical price, is you do not have to try and calculate what the spreads will be and can exit with a market order when your price target is reached.

The example listed has had a recent ABC long trade and continued its bullish move. The skill as a trader is being able to ride these moves and apply appropriate strategies with your stops. The trade on FDX below was triggered on Nov 11 with a very strong bullish push that day, when the market ran past the 50% milestone.

Your initial strategy should have included, that once the price action crossed 50% you move stops to entry plus commission price to make the trade break, even if the trend reversed. This strategy allows the market to retest the entry zone and still keep you in the trade. The other alternative is moving your stops behind the milestone, as they are crossed. How far below the milestone is a constant question asked and rightly so. There is no perfect number but a good place to start is a third of the average daily range.

You will note on the chart I have selected the average range indicator, this displays the daily ranges as an average over any period you define. The software defaults to 20 days or roughly one trading month. I prefer to use three months or 66 trading days, as my default being 3 months of roughly 22 trading days each month.

Using this tool and measuring the value, the average range was $1.37. So, a third of this value is $0.46. That means for this strategy, I placed my stops 46 cents behind each major milestone as it was crossed. As FDX crossed the 50% point or $94.28, the stops were raised to $93.82. The following day the market opened and pushed lower, then closed near its high. The low on Nov 12 was $93.84. We were able to ride the short counter trend and then benefit from prices pushing higher.

November 15 saw the market touch the 75% milestone. Our stops were moved up to $94.89 and we would have been stopped out there on that day. You can see in this example, on one occasion the stops were wide enough to hold us in another day, only to be taken out the next. The rule of a third of the daily range allowed us to stay in the trade and return a $1.53 move in 3 trading days.

Testing how close you run your stops is an important part to your trading. Using the average range tool in the software can help identify the average range easily. As I mentioned, I use 66 days or 3 months for US equites, this is a variable you might also like to modify in your testing.

Good Trading

Aaron Lynch