|Trading Tip: Stops and Exits
by Judy MacKeigan
Let me start out by saying that there are almost as many ways of
using stops as there are trading methods. In my opinion it is the
most personal part of your trading system. Each trader needs to
determine which method they want to use for stops and still be within
their own comfort zone. If you are outside your comfort zone, then
emotions are in position to take over and you will lose the focus you
need to manage the trade correctly.
You should never enter a trade without having a predetermined place
at which you will cut your losses. Yes, you will get stopped out
only to watch price take off like you thought it would, but that is part
of the game we are playing. If fact, if you do not have the right
mindset for taking a loss, it will hinder you from becoming a good
trader. Getting upset over it only takes away from you ability to
focus on what the market is telling you.
Many traders also feel that getting stopped out is a loss. It
really isn't. In fact, you have won. By being stopped out,
you have won most of your money back. Preservation of capital is
so important to be able to continue to play this game. You also
have the ability to reenter if price does eventually go the way you
thought it would. Lastly, you have eliminated the frustration of
not being disciplined by getting out when your predefined stop hit.
One of the signs of a successful trader is having small losses and not
huge ones. Think of that the next time you do not exit immediately
and without hesitation when your stop is hit. Losing properly
requires skill, discipline and maturity as a trader. Some say a
stop is like insurance. A trade without a stop is a gamble.
As a trader, you need to ask yourself if you are going to use the
same time frame for signals, entries and exits or go to a lower time
frame for the entries and /or exits. This is a common practice but
hard for beginning traders to do as they tend to focus on the lower time
frame instead of waiting for the signal to setup on the main time frame.
Once you have learned to do it though, it should improve your results.
One of the most common ways to determine your stop loss is to use the
preceding price bar or the price bar you were filled on. Which one
is used is nothing more than a matter of traders preference.
If you are entering a long above the high of the previous bar you
Use the prior bar stop -- place an initial stop 1 or 2 ticks
below the previous bar's low.
Use the current bar stop -- place an initial stop 1 or 2 ticks
below the current bar.
Some traders use a combination of both by normally using the prior
bar, and then if the risk is too high for their rules, instead of
passing on the trade, seeing if the current bar method brings the risk
back into range for their trading rules.
Using this method for when price is in a trading range:
The stop can either be at the low of the range when long, high of the
range if short. Or if risk is too high then the High/Low (H/L) of
the breakout bar can be used.
Another problem can be created by runaway price creating a long bar
when you are in the trade and using the H/L of the bar would be giving a
lot back to the market. For this situation, I still use what Mike
Bruns taught, which is not to let price get more than 2 points away from
your stop. This assures you of locking in profits while still
giving it some room.
Those of you who use Fibonacci levels might use price targets to exit
This excellent chart posted by Scorp shows two measured
moves (blue lines). Marking measured moves shows how price moves
the same distance after pausing. This chart also shows how
Fibonacci projection of 127% worked again. A measured move is when
price moves up or down then pauses either with retracement or sideways
consolidation and then takes off again in the same direction. The
first move up or down more often than not matches the second move up or
The Ensign Windows draw tool used for the measured move
in the example is the Formations tool. On the tool's property
window check the first three lines, and have the C-D leg parameter set
at 100 so it is drawn at 100% of the size of the A-B leg. You draw
three points, A, B, C and the tool will measure the leg from C to D.
Q: On your first chart, do exit once the stop
price is hit or when the 2min candle is complete which close at or
beyond the stop level? Remember, these candles are changing dynamically.
A: I personally do not wait for the bar to
complete, but then I am not trading off of the 2 minute chart. If
the low of the prior bar is my stop then I am out.
Q: What's a hard stop?
A: A stop that is actually entered with the broker
is a hard stop. It isn't mental. Until you can trust
yourself to execute a mental stop without hesitation, I recommend you
use hard stops. A hard stop is great to have when the power
Price target can also be done with price patterns.
Some examples are head and shoulders, triangle, and wedge,
This chart shows how to project a target from a head and
shoulders price pattern. Many price patterns have their own rules
for projecting price targets.
Other traders use stops to determine when to exit a
trade. We will mention many of them but I am also sure there are
many more out there with new ways being devised all the time. Some
prefer to use trailing stops. In my opinion, for this to work
well, you need to find a "smooth" chart. By this I mean
where most of the bars in an up trend have higher highs -- HH -- and
higher lows -- HL. This will help prevent you from getting
stopped out on small price movements within the trend. Which chart
is "smooth" can change during the course of the trading day.
Once you determine this, it is now possible to use the
prior bar or two bars ago H/L as a place to put your stop. If the
prior bar, you may want to add a tick or two if the trend is strong.
You can also use a larger stop in trailing price.
Another technique is to drop to a lower time frame and
put a Simple Moving Average (SMA) on the highs and another one on the
lows. The chart example uses a 5 period SMA on each.
The upper red line which is a 5 SMA of the highs would
be used as a stop for a short. The lower blue line which is a 5
SMA of the lows would be used as a stop for a long position.
Another method is to use the last swing high for shorts
and last swing low for longs. The following chart gives an example
of using last swing highs for a short.
Many charting programs have a study called Parabolic
Stop. This chart shows an example.
A big volume spike is reason enough for some to exit as
this happens when there are traders taking their profits because they
feel the move is over and other traders are buying to play the price
movement in the other direction. For many traders, the candlestick
pattern gives them the signal to exit. These reversal patterns can
be found at www.litwick.com
Another effective stop method is the high/low stop,
which much of the time is the last swing high/low but tightens on a
longer move. The High/Low stop is the highest high or the lowest
low of the last N bars, plus or minus a slack offset. The slack is
added to the high of the last N bars, or subtracted from the low of the
last N bars. The best slack value to use can be determined
by back testing. A value to use for N would be in the 3 to 5
As you can see, there are many strategies out there. Find one
that is in your comfort zone to use consistently and your trading
results should improve.