Where I Place My Stop Loss
February 2, 2023
Introduction: A stop-loss order can be placed through a broker to sell or buy (if shorting) shares of stock once it reaches a certain level in price. A stop-loss is used to mitigate risk by protecting traders from unprecedented moves in unwanted directions. Today, I will be covering where I like to place these orders when faced with different scenarios.
Scenario #1: When I first enter trades, I always make sure that I can maintain at least a 1:2 risk-to-reward ratio. This means that my stop loss must be at most, half the distance away from my entry point compared to my profit target. In other words, I should be receiving at least 2 times the reward in comparison to the risk that I am taking. This is an important determinant considering that I like to place my stop loss slightly below levels of support (when going long). For example, on January 25, I alerted subscribers that I was buying SoundHound AI, Inc. (SOUN) at the market opening after seeing a significant amount of insider buying.
As shown, I was able to set my stop loss a few cents under previous support . With this stop in play, I was risking 30% of the capital that I put into the trade. I was ok with this since I was expecting a large move to the upside. Following my rules, I made sure my profit target was double my stop loss and as intended, the trade went as planned allowing me to exit position with a 60% gain. But what if price reversed downward? In that case, I would have waited for price to hit my stop-loss and would have been immediately out of the trade. If price starts to trend against me, I never move my stop loss lower. It is important to stick to rules and not let your emotions get to the best of you. If price passes your stop loss, it’s more likely to continue downward anyway.
Scenario #2: Occasionally , when my positions are making large upside moves (again assuming we are long), I like to give them more room to run. Let’s look at another stock alert I sent out to subscribers. On January 9, I alerted the community that I would be purchasing Compass Diversified (CODI) at the market open after seeing cluster buying happening within the company. As shown below, the stock took off.
This time, I did not sell at my profit target, but instead evaluated the trade and decided to raise my target even higher due to the fact that I saw an increase in momentum. I redrafted my trading plan and moved my stop loss up above my entry price. This meant that I would be profitable no matter what and I was still giving the stock some room to consolidate and then break out again.
As shown, I am still in the trade, but I have a new profit target at $23 (not in picture). I will also be raising my stop loss again soon and placing it slightly below the consolidation area around $21.50. All in all, letting stocks run and moving your stop loss up can be very rewarding, but I typically don’t do this because it creates the possible event of me taking profits below my intended target. Technically speaking, this is violating my rules which I don’t like to do.
Conclusion: I never move my stop loss farther down, but occasionally, I do move it upwards in order to let the stcok run and guarantee a profit. Using stop losses is a great way to mitigate risk. Especially, when I am away from my trading desk. For more information on stop losses and how to use them, I recommend checking out another one of my articles here.
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