Every trade is entered with the understanding that it could very well turn into a loss. The important part is knowing what that loss would be, and if it happens, sticking to it. Taking a loss is made easier, more robotic and less personal, if your stop is placed at a level that you can clearly see that the trade is now wrong. To accomplish this stops should be placed at important levels of chart support. Below support lines, below a trendline, below major moving averages, or back below a breakout level.
Equally important to protecting capital when entering a trade is protecting profits as a stock rises. We want to do this in a way that allows us to not just protect current profits, but also leaves room for profits to continue to grow. There are any number of ways to do this. At Wanderer, when a stock begins to move higher and we've got a 3-4% profit, we often move our original stop up to break-even. This ensures we don't take a loss on a winning trade, and is largely a psychological move to prevent the bad decisions that often follow when a winning trade turns into a loser. After that we look to move the stop up more, but using important levels of support as often as possible. We don't use trailing stops (stops that follow the stock at a defined difference in price) as these often leave us with stop levels that are actually just above important support. We instead look for recent daily or weekly lows, levels of resistance that have been broken, gaps that were filled, etc..
Let’s look at some examples:
You can see that MSFT had a strong level of resistance at $141.68. Once this level was broken a trade could be made around $144, and the stop would be placed below the breakout level around $141. If the breakout failed you would be stopped out for a small loss. The stock continued up to around $151 before pulling back slightly to $148.46. It then began moving higher again. At that point we would move the stop to $147.95, just a bit below the pullback low.
SQ would have been purchased on the Wanderer Indicator buy signal around $62.50. The stop would be placed below the moving averages (50-DMA in red) and also just below the recent daily lows, right around $60.50. As the stock continued to climb in a straight line there wouldn't have been a lot of good levels to move the stop to. We would have moved the stop to break-even once we had about 3% profit. Once it broke the 200-DMA (gold line) we would have moved the stop again to the low of three days earlier. If the stock then continued higher we would move it again to the low of the most recent candle showing on this chart around $67.75.
Bitcoin would have been purchased around $11,000 as it triggered a buy signal and broke above the 20 and 50-Day moving averages. Within a few days we would have moved the stop up to break-even. It then continued straight up, running into resistance at $13,868. Because of Bitcoin's volatility we would have given this a wide stop to allow for the possibility of a continued run without getting stopped out. A stop of $12,500 would have been reasonable. Once resistance at $13,868 was broken the stop would have been moved up to the recent lows, back below the breakout level, meaning around $13,000. From there bitcoin went straight up and approached all-time-highs. At this point we expected a pullback and got it, down to $16,200. Once that low was established the stop would be moved to $16,000. Assuming bitcoin broke to new highs the stop could then be moved up to just below the previous all-time-high at $19,892.
QQQ could have been entered on the Wanderer Indicator buy signal around $283.50 using a stop at $279.95, back below the day's low, as well as the moving averages, all of which should have lent significant support. QQQ pulled back sharply, testing the 50-DMA, but not breaking below it, establishing that our stop was correctly placed. Once QQQ began to rise steadily again we could begin to move our stops up, first to break-even, and then slowly into profit territory using the rising 20-DMA as a support level to use as a stop level.
There is no exact science for placing stops, or taking profits. Each trader will eventually figure out what works best for them. However, there are some obvious points to use, as we've pointed out. Look for levels just below support/previous resistance, underneath trendlines, under moving averages, etc.. Also avoid using round numbers for stops. Instead of $50.00, use $49.89. Too many traders lazily use obvious round numbers. Getting your stops just below them will often save you from getting stopped out early.
And most important of all, once you've established a good spot for a stop, stick to it! Taking a small loss, or losing a bit of profit from the highs is far better than letting a loser snowball, or a big win completely disappear. Psychologically, becoming a "Stop Robot" will improve your trading and decision-making 100-fold.