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The Art of Setting Stops
Jan 29, 2008 - It depends on the chart...
I've been receiving a lot of emails asking about where I set my stops. It's an important issue, because no matter how confident I may be about a position, I always have a sensible stop price set on it. My answer to these questions is typically, "It depends on the chart," but I realize how unsatisfying an answer that must be. The logic behind my stops does indeed vary from chart to chart, since each chart has its own nuances, but let me describe a few broad categories of "stop style", if you will. And each one of these is predicated on the same notion of a price level being violated. The nature of that violation varies from chart to chart. The first violation style is the breaking of a lower lower/lower high series. The cascading-down effect of lower lows and lower highs is a potent pattern, but when the price pushes above its most recent "lower high", the pattern is broken. Take BSC, for example. I've put an arrow on the prior high which, if exceeded, would tell me to get out.
Another style is breaking of the prior high. I typically use this when I am betting on a fundamental trend change. This is more speculative, since I am assuming that the stock has only just entered the lower highs/lower lows pattern.
Besides targeting prior highs, sometimes I use a broad zone of either support or resistance. Honeywell is a good example. From my viewpoint, Honeywell has triple-topped at about $62. Each successive top is a little higher than the last, but for my purposes, I'm happy considering this a triple top and using the highest of those prices as my stop point.
Similarly, a stock which has already broken down might offer a clean "line in the sand' after it is already clearly falling hard (as opposed to Honeywell, which is more speculative). ATI, shown below, has completed a nice topping pattern, and I've tinted in green the area of resistance below which the price must stay in order for me to retain the position.
There's another one which really doesn't have a name but I called it the "penultimate high". I place the stop based on the high preceding the absolute high. Chipotle (CMG) is a position I'm holding now where I'm using this.
I could probably write a whole book with detailed explanations about stops and their examples, but that just gives you a taste. And the prior post had hundreds of comments, so I really wanted to get a fresh start for the week! Discuss this article in the forum. ...thanks
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Disclaimer: Please note that charts and commentary provided by the moderator are for educational purposes only. Any trades placed upon reliance on the moderator’s charts or information is taken at your own risk for your own account. Past performance is no guarantee of future results. While there is great potential for reward trading stocks, futures and options, there is also substantial risk of loss and you must decide your own suitability to trade. Future trading results can never be guaranteed. This is not an offer to buy or sell stock, futures, options or commodity interests. Most trading systems are based on historical formulas which have worked in the past. However, what has happened before may or may not happen again. You can lose all your money trading stocks, futures, and options and you must decide your own suitability as to whether or not to trade. Only trade with true risk capital you can afford to lose. Only trade markets you can properly afford to trade. Properly funded trading accounts typically perform better than those that are not. Never risk more than 2-3% of your account on any one trade. Always define your risk before entering a trade and place a stop to limit your risk. There are no guarantees or certainties in trading. Trading involves hard work, risk, discipline and the ability to follow rules and trade through any tough periods during a system’s draw downs. If you are looking for a guarantee, trading is probably not for you. Most people lose money trading. One of the reasons is that they lack discipline and are unable to be consistent. A system can help you become consistent. Ironically, worrying about the monetary aspect of trading can contribute to and cause a trader to make trading errors. Therefore, it is important to only trade with true risk capital.
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