One of the most difficult tasks for traders is determining the right amount of risk exposure when entering a trade. Since every trade must be accompanied by a protective stop-loss order, the question always comes down to “how far should I let the market move against me before I am stopped?”
Some traders are relying on past support and resistance levels to put their stops. However, these areas are often criticized because indoor traders know there are a lot of orders waiting to be taken.
Some traders will draw lines below or above sloping trends and use them as a stop-loss reference, often expecting the market to continue with this pattern. But then, how many times do we see this model being violated when we find out that it exists?
Others will use a percentage value, based on either a fixed profit expectation or a percentage of available funds, to determine their initial stop-loss.
There are many different approaches to choosing a stop loss. My personal preference and what I believe to be the best approach most of the time is to use the expected and confirmed swing price.
What do I mean by “expected and confirmed” swing price?
Since 2019, I have been focusing on the science and mathematics of market behavior for 30 years. Specifically, predict market fluctuations (or turns) in advance. This approach requires a solid understanding of several forecasting methods, including popular and well-exposed techniques involving Fibonacci and Gann ratios, to name just two. There are so many more!
By learning and applying various market timing techniques designed to expose the underlying cyclical behavior of the markets, the trader can then use this information to “ shorten the risk exposure ” of a given trade.
Here is how it works.
Suppose that by using a proven method of determining high probability market turns, you come to the hope that a swing bottom is very likely to occur in the next few days or two (at the latest). Your method typically has an accuracy of 80% or better, so you don’t have to worry about whether it will be on time (say tomorrow) or a day late (the next day).
The reason is that since you already know with a high degree of certainty the probability of the swing bottom, you simply place your buy stop order so that the entry is long just above the high price on the day you are trading. Wait. swing to happen. If the order is triggered, you immediately place your stop-loss just below the low of that same bar because it has just “confirmed” as a swing bottom. Your initial risk exposure is the range of that swinging lower price bar. The likelihood of it holding up and not knocking you out with a loss is very low because you knew with a high probability that the bottom swing was going to happen that day to begin with.
Now suppose the bottom of the swing is a late bar as early as possible. In this case, your buy stop has not been triggered and you can do the same routine the next day for the one day delay bar. The same rules apply.
The real trick, once you’re in your trade, will be to manage the trade and adjust your stop-loss as your position moves deeper and deeper into profit territory. It’s a completely different subject for a completely different article. But for the topic in question, finding the right time and the right price to put your initial stop-loss order where it is neither too small nor too large is not only important, but it can save you a lot of money. money, you keep inside more trades and you avoid trades that you will be happy with later.
So, to reap these benefits, start by learning how to forecast market turns or find a reliable source for this information.