Following my blog on Friday, the question “Where do  I place my stop loss?” cropped up again. It’s an ever popular question from clients when placing a trade. For which there is no one answer. It’s  like asking “How long is a piece of string“. Working out what might make sense, however, is extremely simple.

Let’s say you want to trade a share (this also applies to indices, commodities and FX) which has a tendency to move up/down 10% in a day. Placing your stop loss 2% from the current price might be risky. There is a greater chance of your stop loss being triggered, closing you out of the trade. A UK Index blue-chip with normal volatility of 2%/day is rather different to an AIM share’s potential 10%.

That said, if the current price is very close to support or resistance, placing your stop loss closer could make a lot of sense. Which is my second point. A breach of support or resistance implies jumping a major hurdle, and a significant change in market sentiment (more bullish/bearish). If you think the level will hold, placing the stop loss just the other side could pay off handsomely, boosting your risk/reward if the trade goes your way.

Let’s say you buy a share, hoping the price rises. However, it falls below 6-month lows support. Would you still want to be in the trade? Likewise, let’s say you sell the shares short, hoping for the price to fall. However, it breaks above 2 year highs resistance. Would you still want to be in the trade?

Some traders refuse to use stop losses (I’ve written on this before), scared to close a trade with a loss, fearful/hopeful of the price bouncing back into a profit. My response to this is always the same: “Yes, it might come back, but it might also get worse” and “hoping and watching is not a strategy“.

In fact, I’ve noticed something over the years. Those who now eschew stop losses tended to employ a “one size stop loss fits all” strategy. By that I mean always placing their stop loss the same distance away (e.g. 2%). Irrespective of the price’s inherent volatility. So it may just be that they were using them wrongly all along. Not all companies are the same, so not all shares are the same, therefore not all stop losses will be the same.

Your stop loss is your worst case scenario. Where you decided, in advance, that you’d call it a day, because the shares weren’t going your way. To cut your losses, preserving what capital remained to use elsewhere. It is not where you said you’d review things, widening the stop loss, or worse, removing it all together, merely increasing your risk. The only time to review your stop loss should be to adjust it to lock in profits.

Stop losses need to be placed appropriately, on a case by case scenario. Just as placing them too wide will involve more risk, so too can placing them too close. You’ll likely be looking for somewhere in the middle. Where exactly, will depend.

At Accendo Markets we are here to help you, however you wish to trade. If you need to know the average volatility of a share price over the last few months, pick up the phone. If you need to know the key levels of potential support and resistance, give us a call. Don’t just stick your stop loss anywhere. Take a moment  to think about it. Does this level make sense?

For a host of daily trading opportunities, highlighting important levels on UK Index shares related to Support/Resistance, Ranges, Breakouts and Momentum, get access to our research Gold Pass now!

Mike van Dulken, Head of Research, 25 Jan 2019