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How to set your Stop Loss

Stops are one of the hardest things to master, and there's no easy way to learn how to do it - you just have to experience the market. Learning how to calculate the perfect stoploss size is VITAL to profitable trading.

The most important thing is to NEVER trade without a stop, and most long term traders prefer real stops as opposed to mental stops. This is because the market can turn so suddenly, your 'mental stop' may be passed before you can react. The higher the volatility on the day, the more likely this is to happen.

The next most important point is only ever move your stop in the direction of your trade - e.g. if you are long, only ever move the stop upwards - NEVER feel you can 'slacken' it - that's a very easy way to go bust fast.

The third most important point is that you ARE going to get stopped out. A lot. It's the price of doing business in the market. Your stop is there to firstly protect your capital, and secondly to lock in profits. It can do either or both of those things, of course, and protecting your capital is the most important. You go bust by losing money, not by 'failing to make the biggest profits possible'.

Fourthly, you have to understand what a stop being hit is - it's the market telling you that you are in some way wrong. Either your initial trade is wrong, or the size of your stop is wrong. The market is always right, and you have to become familiar with its ebbs and flows and accept the fact that you can't "fight it". Trying to fight the market is like trying to swim against an oncoming tide - you're going to drown. this is DEFINITELY a situation where 'go with the flow' is appropriate. Even if it sometimes seems like the market is 'out to get you', and you specifically... it isn't. No one even knows you're there (unless you're trading 1,000 contracts, of course, in which case you have a different set of problems!).

Now on to how to set your stop. There's no formula for this - as I said before, you have to gain experience in your market, which is why most pro traders focus very strongly in one area - they get familiar with it. The S&P mini is as good a place to start as any, and in fact, a great many pros trade nothing else - it has excellent liquidity, and good volatility - what you need to make daily profits. To figure out the perfect stop, you need to look at what is happening on the day, and work out a 'rough' figure that will allow your trade to roll without getting stopped out by intrabar movements. Right now, we're using about 2 points again - if volatility increases, we increase the stop the next day and vice versa.

If you find yourself constantly getting stopped before your trade gets going, your stop is too small. If you find yourself 'handing back' too much of your profit, your stop is probably too big (or you aren't moving it often enough). There's a magic figure that will work on the day for you. What I'd suggest is that you either trade a very small size, or even paper trade, until such time as you have got the feel for it. When your trade has moved into profit, including costs, and you can safely move it in the right direction (i.e. UP if you're long, or DOWN if you're short) do it. You may get stopped, but you have at least a break-even on it, and that's a *very* nice feeling - when you can't lose, and are effectively playing with someone else's money.

If you can get a 'feel' for how to set it, (and the charts should really help you in this) you will find it hard NOT to make money, because the entry points are fairly straightforward, and the amount of profit you make is therefore dependent on where you exit.










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