Placing stop losses is an important risk management technique used by traders to limit their losses when trading financial instruments like stocks, forex, or cryptocurrencies. The placement of stop losses can vary depending on the trading strategy and the specific asset being traded.
We have always been told – and is a market myth – that our stops should not be more than 1% to 2% of our capital. This strategy may not yield the required results always. Say if the daily range of stock is around Rs.20 and you are placing a stop loss at Rs.2 or Rs.3, which is 1% of your capital, then the stop loss is definetly bound to get hit. If we continue with this strategy then our losses will pile up and this is turn will make us loose our confidence and when we loose our confidence we will fail to be a disciplined trader. We have to take into account the daily movements of the stock and then decide on the stop levels.
Here are some general guidelines to consider when placing stop losses:
- Determine your risk tolerance: Before placing a stop loss, it’s important to assess how much you are willing to risk on each trade. This will help you determine the maximum loss you are comfortable with and set a stop loss accordingly.
- Identify key support and resistance levels: Support and resistance levels are areas on a chart where the price of an asset has historically shown a tendency to bounce or reverse. Identifying these levels can help you place your stop loss at a level where the price is less likely to break through.
- Use technical indicators: Technical indicators such as moving averages, trend lines, or the Relative Strength Index (RSI) can provide valuable information about the trend and momentum of an asset. You can use these indicators to help you determine where to place your stop loss.
- Consider the volatility of the asset: Highly volatile assets like cryptocurrencies may require wider stop losses to account for the large price swings, while less volatile assets like blue-chip stocks may require tighter stop losses.
- The daily range or movement in the stock: This is very important to arrive at the stop loss. If we do not take care of this then it is possible that our stop losses will get hit everday. The stop loss should be decided after taken into account the movement of the stock during the day.
- Adjust your stop loss as the trade progresses: As the price of the asset changes, you may need to adjust your stop loss accordingly to account for any changes in the market.
The placement of stop losses should be based on your risk tolerance and the specific characteristics of the asset being traded. It’s important to remember that stop losses are not a guarantee against losses and can be triggered by market volatility, wrong stop loss levels, or other unexpected events.