Stops-Trading Tool

Your simple and easy guide to stops.

  1. What are they?
  2. Why are they vital?
  3. When do you need them?
  4. How do they work?
  5. What are the different types?
  6. Example – Stockradar’s type, use and implementation
  7. The key to a successful stop strategy!
  1. What are they?

 What Is a Stop-Loss Order? 

A stop-loss order is an order to buy or sell once the stock reaches a certain price. A stop-loss is designed to limit an investor’s loss on a stock position. Setting a stop-loss order for x% below the price at which you bought the stock will limit your loss to x%. A stop should never be moved down.

What about stop-profit?

As the price moves higher so to should the stop. The stop begins with a x% risk limit and as the price rises so to does the stop. The initial objective is to move the stop to the break-even level and as the price rises further it becomes a ’lock in profit’ stop. Where to set the stop is a point of much debate. The key, as often happens with those without rules or stops, is that investors let the price drift right back down to where the rally began or even lower as every day, they ‘hope’ things will get better. They rarely do. The stop usually knows best and at the very least it ensures your losses are limited and profits are protected and that’s very important when trading.

  1. Why are they vital?

The stop is a tool to take the emotion out of trading and provide risk and profit protection. Don’t kid yourself we all need them. It is predetermined event with the dual effect of limiting losses and protecting profits. They work well when implemented as part of a complete trading plan.

  1. When do you need them?

Markets move in different ways so determining a one size fits all is impossible. The aim of a stop is to ensure your profitability by limiting losses and protecting profits you have built up. This will depend very much on the quality of your entry analysis but that’s the idea.

Because a stop requires the price to turn down by a certain %, that % is the amount you are prepared to ‘give up’ when the market turns. It it’s too tight you get whipsawed and if it’s too loose your profits are eroded. So, setting stops and accepting them requires a certain expectation that disappointingly maybe, but realistically, you will never get the top. Part of trading is accepting those horrible realities.

However, the benefit is we don’t know how high a stock will move when it is trending higher and they do often exceed our expectations. So be always using a stop we are hopefully better prepared to capitalise on a major portion of the trend than by selling simply because the price has jumped quickly, and we have a nice quick profit. The name of the game is maximising those opportunities and that won’t occur if you sell without a method, and a stop method is a good one.

  1. How do they work?

There are different ways to base a stop on and set it. Now that we know that we need one, the next step is to where to set it and how we arrive at that stop setting. You can look into Percentage Stops, Swing Stops, Moving Average Stops and ATR Stops. These are all tools that are helpful in managing stops. Not an exhaustive list but it probably covers most types. It comes down to your style, personal preference, and time frames amongst other variables that might make you choose one stop over another. There are lots of explanations on the web that explain these different types and I have provided some links below for you.

There are stops tied to price and accelerating stops. Stops that stand still and stops that over time force a resolution, stops that are too tight causing whipsaws and stops to far away letting too much profit slip away. Yes, you now probably can see there is no perfect stop, unless you consider a stop that allows you to make money as perfect. That is as near as you will get just as every trade is not a winner, but if most are……

Just as trading is based on probabilities so too to a large extent is the setting of stops. When building a designing a trade plan, stop variations should be tested. Like the trade plan a personal favourite will emerge that makes sense to your style of trading and most importantly makes you money – consistently. It might require some minor tweaking every now and then. Just make sure it is done on a qualified and sensible basis and not simply a reaction to one market event.

Below are the Incredible Charts links which provide a simple but comprehensive explanation of various stop types:

  1. What are the different types?
    • ATR Bands
      Average True Range (ATR) Bands are used to signal exits in a similar fashion to ATR Trailing stops, but without the stop-and-reverse (SAR) of trailing stops.
    • ATR Trailing Stops
      ATR Trailing Stops are primarily used to protect capital and lock in profits on individual trades but they can also be used, in conjunction with a trend filter, to signal entries.
    • Chandelier Exits
      Chuck LeBeau’s Chandelier Exits are primarily used as a stop loss mechanism to time exits from a trending market.
    • Ichimoku Cloud
      Ichimoku Cloud is a complete trend trading system, combining leading and lagging averages with traditional candlestick charts.
    • Parabolic SAR
      Developed by J. Welles Wilder, the Parabolic SAR indicator provides excellent short/medium-term entry and exit points in trending markets.
    • Percentage Trailing Stops
      Percentage Trailing Stops are a simple but effective method for locking in profits
    • Safe Zone Indicator
      Alexander Elder’s Safe Zone Stops use Directional Movement to signal exits from a trend.
    • Volatility Stops
      Welles Wilder’s original Volatility Stops uses Average True Range in a trend-following system.
  2. Stockradar types, use, and implementation

My style is to try to adapt the setting of my stop to market conditions, but the setting is ruled by certain boundaries.

  1. Initial stops are set at a maximum of 15%. That is my risk on any one trade.
  2. Stops never move down.
  3. As the price rises the stop trails by 10-15% with the intent of getting is as quickly to breakeven as I can.
  4. Within that 10-15% I search for price lows or moving average points to help guide me.

Recently I have made a refinement to my stoploss setting which has primarily been the result of seeing too much profit disappear in certain instances. Using experience-based knowledge of how stocks move under certain conditions it has led to the refinement. It has enabled me to move the stop sensibly (never down) in response to market conditions so I am not fixed to a maximum risk from the highs of 10%. I can now tighten the stop under certain conditions to levels tighter that 10%.

The ‘Accelerated Stop’ is tightened further than the predetermined 10-15% level to protect a greater portion of profits under certain conditions. It is a ‘momentum’ based stop which can either be when momentum slows or is excessive. Some stocks have the requirement for lifting stops further than the ‘defined predetermined limit’. Below are some examples where I might adjust the stop tighter than the 10-15% band.

  1. A low volatility or a stagnating trend. By stagnating trend, it means when a stock’s price is well above its stop, but the exponential moving average is also well above the stop. It entails using the exponential moving average as a benchmark or previous lows to raise stops further from the predetermined stop level towards, or in some cases even above, the Exponential Moving Average (XMA).
  2. A stock is approaching overhead resistance ad hesitating
  3. A stock has exploded higher.

Price violations of 1% are required to confirm the violation of stop levels.

The trend and momentum methodology Stockradar employs is suited to the trailing stop loss process. Trends can be an ongoing development and on occasions we may be taken out before a trend ends because there is no perfect stop. But by working this stop process within a trade plan that always buys a new high we can lock in profit but always be exposed to trend that moves higher.

  1. The key to a successful Stop strategy

The key to an effective Stop strategy is actually using them. This may seem a strange thing to say but setting them and actually executing them properly is sometimes harder than you think when under market ‘pressures. Think the Nike motto – Just Do It.