Trading is a game of probabilities. No matter how accurate the analysis of a trader, there is still a chance of things going wrong. There are circumstances where the trade may not go as planned. To avoid any significant losses after taking a trade, the trader uses stop loss mechanism. Stop loss is used as a risk management tool that allows the trader to minimize the losses. This helps the trader define the amount of risk they want to take. In this newsletter we understand Stop loss and how to place them.

Stop loss orders – a gift to the traders

Stop loss is an order that is automatically placed when the price moves beyond a set level. This level is called the trigger price. There are two types of stop loss orders: Stop loss limit order and Stop loss market order.

Stop-loss limit order is a limit order that is placed by the system automatically when the price reaches the trigger price. The limit order allows the trader to limit the buy/sell price.

Stop-loss market order is a market order that is placed by the system automatically when the price reaches the trigger price. Market order fills the order at any price available in the market.

Okay, but where should I place them?

In a broader sense, stop loss levels can be of 5 types:

1. Affordability stop loss

2. Pattern stop loss

3. Support and Resistance stop loss

4. Swing stop loss

5. Risk per day stop loss

Affordability stop Loss

Affordability Stop loss levels are the levels where the trader will exit the trade to limit the further losses. It is a predetermined percentage or amount of loss a trader is comfortable taking. Any losses beyond this point may not be desired by the trader.

Pattern stop loss

Pattern Stop loss are the stop loss placed based on the negation of the pattern. Each pattern conveys a specific information to the trader and the negation of the pattern is the point where the pattern becomes irrelevant. This negation point of the pattern can be placed as a stop loss. For example, a bear trap pattern on PnF chart is a powerful pattern and shows that the bears are now tapped after the DBS breakout. The stop loss levels for this pattern would be the DBS levels of the breakout column. As the pattern will get negated and trap will be converted to Broadening pattern. Although, this type of stop loss seems logical, it can be outside the trader’s comfort zone.

Support and Resistance stop loss

The third type of stop loss is based on Support and Resistance levels. This type of stop loss is used mostly by breakout traders. In this type, the stop loss is placed at a point that is deemed to be an important Support or Resistance point by the trader. For example, when the price of a stock is near the All-Time High price, this zone is acting as a Resistance. When the price gives a breakout from this point, this ATH levels becomes an important support and is a great level to place the Stop loss for the trade. Support and Resistance stop loss can be placed for specific patterns as well. These are usually consolidation or reversal patterns such as Rectangle or Head and Shoulder pattern, where low/high of the pattern can be used as a Stop loss level.

Swing stop loss

This type of stop loss is used by swing traders. When the price is in an Uptrend, it forms, Higher Highs and Higher Lows. In a Downtrend, the price forms Lower Highs and Lower Lows. A swing trader would participate long at the breach of the Higher High and keep the recent low as the stop loss levels. Similarly, the trader would participate short at the breach of the Lower low and keep the recent high as the stop loss level. When the stop loss levels are breached, it would mean that the setup has changed.

Risk per day stop loss

The fifth type of stop loss is absolute amount of loss for a particular day. This type of stop loss is used by intraday traders. No matter the number of trades taken per day, the loss shouldn’t cross a given level. The stop loss is placed accordingly.

In my experience, using Pattern stop loss is ideal and logical. The reason being that when this stop loss is triggered, the setup changes. But, as noted earlier, the loss could be out of the trader’s comfort levels. In this situation, the trader must be patient to wait for a pattern formation whose stop loss is within their risk tolerance limits. Another way to deal with this situation is to analyze the charts on a multiple timeframe. Take entry & place stop loss on the lower timeframe based on the patterns formed on lower timeframe while the trade is in the direction of higher TF.

In my courses, I teach the patterns that form on various charting methods and their negation levels as well. When combined with indicators and other tools, these patterns make for a complete trade setup. All the courses can be accessed through the subscription to TNT one. You also get to be part of a trading community that follows noiseless trading and get a valuable learning experience in the Weekly market analysis live sessions. If you haven’t check it out, click the link below.