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2024/07
4 efficient stop-loss strategies to help you avoid over 80% losses
Most market losses stem from poor entry and exit timing. For many traders, exiting a trade is the hardest part, even though seasoned traders constantly stress the importance of setting exit rules.
Many traders enter trades without setting stop-loss points or profit targets, leading to significant losses. Here are four efficient stop-loss strategies to help most traders avoid over 80% of their losses.
1. Indicator-Based Stop-Loss
As the name suggests, this stop-loss method relies on indicators. Many predictive indicators used in trading are intraday indices, such as up/down ratios, new highs/lows, and volume. The relationships among these indicators and between indicators and prices are constantly changing. Traders spend a lot of time testing to understand the relationship with expected price movements.
Creating this strategy often involves answering the question: What happens when these candidate indicators reach extreme values? Is there a continuation of the price trend or a reversal? These insights can significantly improve a trader’s stop-loss strategy.
When creating an indicator-based stop-loss, if the price breaks a new high or falls to a new low (if you’re shorting at a new high or buying at a new low), you should exit the trade, even if the price hasn’t reached your set stop-loss level. Studying intraday indicators over different periods allows you to develop your technical indicator stop-loss points to fit your trading style and methods.
2. Time-Based Stop-Loss
A time-based stop-loss strategy means making short-term trades when price momentum rises in the expected direction. You should quickly reach your profit target if your price direction is correct. Conversely, if the price doesn’t increase after a long or even falls slightly, it indicates that the price direction analysis was incorrect, invalidating the initial assumption.
For example, design a trading system with a holding period of 21 minutes to capture a 3-point profit. If the expected profit is reached within 21 minutes, exit the trade immediately, even if the price has yet to hit the stop-loss level. This time-based stop-loss allows traders to pause trading promptly, avoiding further losses after a slight decline.
The risk, return, and holding period of each trade is proportional. When designing trading methods, include the holding period to ensure it matches your risk tolerance. Once the system is established, the time-based stop-loss will complement the price stop-loss strategy mentioned next.
3. Price-Based Stop-Loss
Most traders are familiar with price-based stop-loss strategies since the price is the most obvious indicator, directly reflecting potential losses. When time and indicators fail to exit a trade, the price-based stop-loss is the last resort.
Consider each trade a hypothesis. Treat the previous low as a potential low point if you go long on a one-minute chart. In such cases, set the stop-loss at the last low when entering the trade. The assumption is that the current uptrend’s previous low and the first retracement are significant. If the price returns to the last low, the hypothesis is invalidated, necessitating an exit to protect the remaining capital.
The key to implementing price-based stop-losses is to set the stop-loss point near the assumed high or low, ensuring minimal losses if the hypothesis is invalidated. Check one-minute and five-minute charts for short-term trading, and consider market maker quotes for buying and selling.
4. Capital-Based Stop-Loss
Capital-based stop-loss means stopping a trade when the invested capital loses a certain amount or percentage. This method is relatively rational, preventing significant capital losses and psychologically preparing traders for potential losses, making trading more composed. There are three ways to implement capital-based stop-loss:
- Fixed Amount Stop-Loss: Exit a trade when a position loses a fixed amount, regardless of future events. Prioritize the set loss amount above all else to control trading losses effectively.
- Fixed Period Fixed Amount Stop-Loss: Set a daily or weekly loss limit for each position. This lets you pause and rethink your trading strategy when trades aren’t going well, restoring a calm mindset before resuming trading.
- Total Capital Stop-Loss: Only put capital you can afford to lose into the account, meaning all account funds can be lost without adding more. This stop-loss method focuses on external capital management rather than internal trading, making it a highly rational approach.
Summary
Given the market’s uncertainties, no matter how experienced or skilled a trader you are, you can only partially avoid losses. Therefore, every trader should learn to minimize losses during trades. This is the key to long-term trading success. The market will inevitably sweep out trades without stop-loss measures.
