The Art of the Stop Loss: Technical Primer
For technical analysts though, stops are perfectly suited to this style of trading. That's because technicians base stop levels on key areas of support and resistance (in the case of a short-side trade, of course), areas that act as intermediate price floors and ceilings for shares of a given stock. That's even more significant because generally a broken support level or trend line means that the technical setup is broken and it's time to get out of shares.
Fundamental investors see deteriorating company values -- such as debt increases or revenue drops -- as a reason to unload shares; because technical investors use market conditions to determine whether a trade is still worth owning, stops make a lot of sense to use.
Picking Out Your Stop-Loss Levels
Implementing stop losses on your trades isn't as difficult as it first appears. I've long held that any trader worth his salt has his exit strategy in mind before ever placing that first trade. You should be well aware of the conditions that break your technical setup ahead of time. Not surprisingly, you'll want to place your stop loss at those levels.To learn more about determining support and resistance levels for your stops, check out the primers on Support and Resistance, Moving Averages and Trend Line Support. Of course, picking stop loss levels becomes tougher in practice. Intraday whipsaws can trigger stops even if shares trade low for just a few minutes on a given day. To combat that, placing stops several percentage points below a support level is an effective method. While it'll mean that you get a lower fill price if a stop does get hit, the chances of seeing that stop violated are significantly lower. Another effective way to use stops is by not using stop loss orders at all. Instead of using "hard stops" (real orders that can trigger on a certain price break), attentive traders may want to consider mental stops that are tied to alerts generated by your trading platform. While more subjective than hard stops, some experience in the markets can often help you determine whether that intraday stop violation is likely to hold, or whether it's just a whipsaw. Deciding to only honor stops when a stock closes below your condition prices is another way to accomplish this same objective.
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