A trader’s goal is to enter a position early in a trend and ride that position until an objective or target price is met. Catching a trend is difficult enough; squeezing the last dollar out of a trade is even harder. Stop loss orders are used to set risk. As another option they can be used to manage profitable trades with an order type known as a “trailing stop.”

Setting a Stop Loss

Once a position is taken, the next step is to set a stop loss price. When a stop loss order is triggered, it becomes a market order. This means a buy stop will be filled at the next available offer and a sell stop will be filled by hitting the next available bid. Sell stops are set below entry and buy stops are set above. Stops are mainly used as protection against unexpected reversals in direction. The trick is to select the correct stop loss price that is far enough away to stay in a position versus closing it out with reasonable risk.

Risk varies for all traders. Account size and time frame are critical when defining risk. When taking a short-term bullish trade, I like to set my stop loss at a price that is 50% of an average day range below the entry level. If a short position is taken, I set a stop loss 0.5 ADR (Average Day Range) above entry price. Choose a stop loss percentage that fits your risk profile.

Trail Stops to Lock in Profit

To ride trends longer while increasing profits, it is a good practice to utilize a trailing. When entering trades deemed to be swing trades or longer-term trades (3-5 days), I use a trailing stop technique. First you need to determine a daily and weekly ATR (Average True Range). A 14-day and 9-week ATR are the benchmarks I use to be current with volatility.

Guide for Trailing Stops

Assume we have a signal to buy a 40 of XYZ stock at $50, and the ADR (Average Day Range) is $8 and the AWR (Average Week Range) is $20.

Long 40 XYZ @ $50

• Set risk (stop loss) = 0.5 ADR ($4) minus entry ($46 = stop loss)
• The next step is to set profit targets. To do so refer to ADR and AWR.
• Target 1 (T1) equals 0.5 ADR above entry price on a long position or $54.
• If target 1 price is reached ($54), sell 25% of the position or 10 XYZ for profit of $40.
• Stop loss for 30 remaining stocks moves to entry ($50). At this point if the market reverses the rest of trade will be a scratch. The goal is to reduce risk just in case the trend higher does not materialize.
• Target 2 (T2) = 1 ADR or $58 (entry + ADR). When this level is touched take profit on 10 more of XYZ. 

Pnl up $40 + $80 = $120

• Stop for remaining 20 XYZ jumps to T1 or $54. Now if the trend reverses a profit will still be realized. Trailing stops lock in profit.
• Target 3 (T3) = 0.75 of AWR (entry + $15 = $65). If T3 is attained sell 10 more XYZ for + $150.

PnL up $40 + $80 + $150 = $270 and still long 10 XYZ

• Stop moves to T2 or $58, thus locking in more profit.
• Target 4 (T4) = 1 AWR plus entry or $70 ($50 + $20). If T4 is realized, exit position on last 10 XYZ for +$20 x 10 = $200.

PnL (if all targets hit) $40 + $80 + $150 + $200 = $470

Final Thoughts

Stop loss orders can be used to preserve profit. They are a great way to eliminate risk quickly and accelerate profit potential as the market moves to projected profit targets.

John Seguin, Market Taker Mentoring