Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

How to Set Stop Losses to Lock in Profits

InvestorEducation / Investing Feb 16, 2007 - 07:17 AM GMT

By: Hans_Wagner

InvestorEducation I have had several questions regarding how I set stops and why sometimes I use a trailing percent stop and other times I use a specific price. I hope to help clarify my approach with this Point of Interest. The trailing stop is an excellent method to lock in profits or protect from greater losses. By placing a stop order below the current price it limits your loss to a predetermined amount. When the bid price hits the stop price your position is sold and you exit your position. 


The goal of a trailing stop is to let your profits run while protecting most of them in the event of a change in the stock's trend. The trailing stop should be far enough away from the current price level to compensate for normal volatility as price moves in a larger trend. While this article is based on long positions, the same concepts hold for short positions as well.

There are three primary ways to set a trailing stop, two of which reset automatically. The three trailing stop methods are: 

  • A percentage below the current price; 

  • A fixed number of points below the current price and; 

  • A specific stop price based on a technical indicator or support level that you adjust as the price of your stock raises. 

Trailing Percent

The trailing percent stop trails price movements by a set percentage, but only in the direction of the trend. If the price reverses direction, the stop remains at its previous level and will be activated if the price falls below the trailing percentage. The trigger price is readjusted each time a new high is reached. If the stock's price begins to fall and reaches your calculated stop price, your order will be triggered as a market order and your stock will be sold for the best available price.

Setting the percent for the trailing stop depends on your personal risk capacity, the trend in the market and the volatility of the stock. For me I do not wish to take on a lot of risk, which is why I like to buy quality companies at a discounted price. As a result I believe I can have a lower trailing percent than many other people use. When the market is trending strongly up, a trailing percent can be slightly larger than when the market is flat or in a secular bear market. It gives the stock more room to move on its way up. Finally, the volatility of the stock helps to establish the percent. The article Setting Trailing Stops discusses a way to calculate the trailing percent based on the latest month's volatility.

Trailing Points

Another way to set your trailing stop is to use trailing points. This method is very similar to the trailing percent method, only you use a set number of points below the high price, instead of a percentage. If the price reverses direction, the stop remains at its previous level and will be activated if the price falls by more than the trailing points. The trigger price is readjusted each time a new high is reached. If the stock's price begins to fall and reaches your calculated stop price, your order will be triggered as a market order and your stock will be sold for the best available price. 

Specific Price

The third way to set a trailing stop is to use a specific price. This technique takes advantage of the market psychology that is imbedded in the price and volume of a stock. Technicians call these levels support and resistance. Support is the level which a stock seems to find more buyers than sellers and as a result usually has difficulty going lower. Support levels are where buying overcomes the selling that is causing the price to fall. Resistance is the level where a stock seems to find more sellers than buyers and usually has difficulty going higher. Often these areas are where the stock price has stopped going down and started going up again. Unfortunately, setting a price just under a support area does not automatically move up on its own. You must monitor the price movement and adjust the stop price on your own.

My Basic Approach

The ideal stop limits down side risk without executing on a pull back within a rising up trend. When setting the initial and then trailing stop I go through a progression as follows:

1. Look for support levels on the chart that includes key moving averages such as the 50 and 200 day. Note how many times the support level has held and the volume action as the price maneuvers near the support level. If there is stronger volume on the move up away from the support level it is a good sign that this is a strong support level.

2. Calculate the trailing percent stop. This gives me another estimate of where to place a potential stop.

3. Select the best stop method to use given the specific situation of the stock in question. This decision is based on your best judgment and experience. If support levels are very close and the percent stop would give the price more room to move, I will select the percent stop. If there is support just below the percent stop then I might select the specific price just below the support level rather than the percent stop. In each case I decide how much I am willing to lose with each approach. 

4. Monitor the price performance and review which stop method to use as the price move up. There are times when the percent stop is best and there will be times when the specific price just below a support level will be best. As the price approaches your target, you may want to tighten up your stop to be sure you capture the most profits.

Trading for a Living: Psychology, Trading Tactics, Money Management
$41 (45% discount)Trading for a Living: Psychology, Trading Tactics, Money Management

 

Below is a chart of ALJ. Here is my thinking on setting stops for ALJ. Originally, I used the percentage stop to begin the trade, as I believe it was the best way to begin. It provided sufficient initial room for the price to move, without risking more money. Later as the price rose, I felt the rising trend line and the 200 moving average was a better place to place the stop. I am expecting this trade to last for several months, so I want to leave some room for it to move before getting stopped out. However, if you are a shorter term investor or feel that you would not want to risk the additional downside that a lower stop offers, then I would stick with the 8.7% stop. You might also believe that if the market consolidates and possibly pulls back and take ALJ with it. This would be another reason to stay with the 8.7% stop. You can always buy back in.

Below is a chart of ALJ. Here is my thinking on setting stops for ALJ. Originally, I used the percentage stop to begin the trade, as I believe it was the best way to begin

Conclusion

So which trailing stop should you use? I am unaware of any study that statistically proves one is better than the other. Successful investors and traders use each method. I like to use both the Percent Volatility and the Specific Price based on support and resistance levels. These two methods have some basis in behavioral psychology of the market. I examine the stop each method identifies and then choose the one that seems to fit the current situation the best. I also use what I know about the overall market trends and cycles, the strength of the trend in place and the general economy to help set my stop.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in