Win More With Better Stop Placement
Figuring out the proper stop loss when day trading, whether experienced or novice, is always a tricky subject. One thing is most certain, those traders that consistently do not use stop loss orders face almost a 100% chance of losing a significant amount of money, if not all of it. Even using stops, if they are inapropriate, will result in net losses no matter how good the stock pick is. Additionally, adding to positions in front of economic data to be released or other unpredictable events can assure higher odds of getting stopped out because of increased volatility post release.
The main thing to keep in mind is CURRENT MARKET CONDITIONS – I cannot stress this enough. Do not pay attention to what the indexes are doing, it is what many stocks over various sectors are doing overall and how they are trading in general. What is the general volatility level for the day, is stuff trading slow and steady or are they whipping up and down quickly on a slight move in the futures market? This makes a large difference in not only the stop placement, but in the overall risk level for the trade. Most people assess risk by the amount one can lose when using a day trading robot or just trading on their own with chart setups. What most people fail to think about is the actual odds of that loss happening.
While there is no sure fire way to figure out odds, if you watch what other stocks are trading like you can get a pretty good idea. If conditions are calm, you might be able to use a smaller stop – a 30c stop has a 30% chance of getting hit for example. When conditions are frantic, a smaller stop is almost assured to get hit – meaning the 30c stop has a 98% chance of getting hit even on the exact same name.
The way you figure the odds in a stop happening when day trading is somewhat straightforward. Look at the average range over the last 20 minutes or so, the high to the low area of the bars. Do not pick the most calm period of time, as this tends to not stay constant. If current times are super calm, go back on the chart to a more volitile period for the day (or another day) and then figure the range. It does not need to be an exact amount, we are just looking for an approximation. Once you have measured this range, this becomes your maximum risk.
What we want to do is to lower this max amount to a lesser level. This can be accomplished in 2 different ways. The first way is to study the pattern of trading behavior for that stock locallly when it reaches a prior high level – does it normally fade back or does it have momentum and push through? If it tends to push (last few times it reached a high turn point), then its ok to buy the stock on strength. If it tries to sell, or looks like a fade back – wait for it to push and then put your order in at 1/4 of the range computed, but lower than the high its at currently. So if the price range figured was 1.00, and the stock was at 40 now, you would put your order at 39.75 to go long. You will most likely miss some trades doing it this way, but have to ignore the urge to chase the prices. If a similar pattern is occurring on a lot of other stocks (in general) you have to be extra careful.
A second way to remove some of the risk is to split your entry order into 2 different parts. So if you want to buy 500 shares, only buy 200 now. Wait until it pushes a decent amount up (meaning it has pushed enought that it has moved past the fade the breakout move area), then look to add the other 300 on a 5 or 10c dip. Move your stop up .45 now (figuring you have a 1.00 stop to start) on the whole thing. The other choice if the price tends to fade after pushing higher is to buy 200 shares now and then place the balance of your order .25 above your stop price level (figuring it is 1.00). The maximum stop loss level should remain the same on all the accumulated shares. The difference here is if market conditions get poor for going long when day trading for a period of time, you are going to lose a lot more averaging when its selling because you will get filled on the add, then stopout 2 minutes later on all of it.
The easiest way around this situation is to lower your share size – when upredictability sets in, trade only 1/2 your normal size. The name of the game is preservation of capital first and foremost (hence the stops), but second its to avoid easy loss situations. While is is very difficult to actually tell that trading conditions are improving without actually trading, it is a very good idea to trade with less shares until you visibly see conditions look better over time.
