Do you find placing your stop-loss points to be a daunting task? Are you torn between: “is it too close or too far”? There are a few factors to take into account, but it doesn’t necessarily have to be that hard.
We’ll begin with quick definitions and list the factors that impact the placement.
Tight vs. Wide Stop-Loss Points
A tight or close stop loss point can be less than a few pips from the level of support or resistance. In case you are trading a breakout to the downside, you may want to place your stop-loss point just several pips above the line of support. So, you enter the trade on a break below that support line, but exit the trade on the first sign that the trade is going in the other direction.
A wide or far stop loss point takes the other approach. If we stick to the downward break scenario, a wide stop loss would not be just above the line of support but rather higher above, perhaps above one line of resistance.
4 considerations
- Is it the first attempt?: “Fakeouts” or false breaks are just too common. However, they may serve as a signal for a larger trade, a real and big breakout. If the move you are seeing is the first attempt to break support or resistance, perhaps a tight/close stop loss point is the way to go. In case the break is fake, you will not be losing too much. Yet if it is the second move, there is a greater chance that this is the real thing. And if it is the big breakout, you do not want to exit the trade too quickly. A wider stop would be able to absorb a small pullback before the pair makes a huge break.
- Make the trend your friend: This old cliche is relevant for breakouts and stop-loss points. If you are following the saying and the trend, you can feel more confident and set a wider stop-loss point. If you are going against the trend, perhaps a tighter point would be more suitable.
- The other point: When you enter a trade, you place a stop-loss and a take-profit order point. A sound trading system takes the risk-reward ratio into account. So, if your take profit point is around 60 pips from the entry point, perhaps your stop loss point should be around 20 pips away, maintaining a 3:1 ratio, which is a common rule of thumb. In any case, the reward should be greater than the risk and it is another thing to consider.
- Is it a predictable pair?: Some pairs are easier to trade than others and they have different characteristics when dealing with breakouts. Does the pair have a more predictable behavior with such moves? If so, the stop-loss point can be set wider afield. If not, perhaps a tighter stop is warranted.
Do you have a method for placing your stop loss points? In any case, if there’s one thing you should NOT do, is skip placing these points.
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