Market is a living breathing entity in continuous motion. The market goes in one direction. It has a correction. Then it continues back in its trend direction. It has another correction and so on. Even in sideways or choppy market, there are ups and down in the price action. The market is always ebbing and flowing. Its like the waves in an ocean.
It is like the continuous ebb and flow of the tides. You must learn to ebb and flow with the tides in the market. Setting stops on the key levels of price support are crucial. These key support levels represent significant market realities occurring with enough trade volume to warrant a stop loss level.
There is a continuous ebb and flow in the market. Even in case of a perfect trend this ebb and flow is superimposed on the trend. How do you reduce the possibility of getting stopped out of a perfectly good trend by the normal ebb and flow of the market? The market will continuously fluctuate. The answer lies in the current price, volume and volatility of the market.
You will need to ensure that your trading system and approach take these factors into consideration so as to allow your stops to ebb and flow with the markets. The stops need to protect you from risk but they also need to allow the market freedom to fluctuate.
The market will tell you where to set your stop loss if you know how to listen to the market. To choose a random exit that does not include the crucial information the market is giving you at any time is ignoring what the market is telling you.
First learn to understand the market dynamics. Then you need to learn how to identify the correct stop loss based on the market dynamics. Then learn to adjust your trade size to manage your dollar loss. Never ever use an arbitrary dollar amount like, I will get out of the trade when it goes against me $200.
How many risks there can be when you enter a market? A stop loss protects you from different types of risks. The value of having the stop loss in place prior to entering the market is that you can unemotionally determine the best exits possible for the different types of risk like the trade risk, the market risk, the liquidity risk, the margin risk, overnight risk and the volatility risk.
Your stop loss position is determined by how much risk you are willing to take. The position of your initial stop should be based on the rule of 2% risk on your trading account. For some advanced traders it is sometimes beneficial to risk more than 2% of their trading account on a single trade. However, the amount these traders risk must be carefully calculated depending on their proven historical performance statistics.
One of the greatest challenges for any trader is to finally come to the point where he/she firmly believes that a sound money and risk management program is vital. Placing stop loss correctly is an important part of the money and risk management program. Remember the saying that there should be some method to your madness. Learn the yin and yang of trading.
Author Resource:
Mr. Ahmad Hassam is a Harvard University Graduate. Try This 1500 Pips A Day Forex Signal Service from heaven! Learn These Candlestick Patterns !
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