Make More Money With A Good Stop Loss
Figuring out the proper stop loss when day trading, whether experienced or novice, is always a tricky subject. One thing is most certain, those traders that consistently do not use stop loss orders face almost a 100% chance of losing a significant amount of money, if not all of it. Even the prudent use of stops, if they are placed in the wrong area, will result in consistent losses no matter how good the stock idea is. In addition, adding positions before market moving news events occurs can assure increased volatility and increased odds of stopping out.
The main thing to keep in mind is CURRENT MARKET CONDITIONS - I cannot stress this enough. Do not pay attention to what the indexes are doing, it is what many stocks over various sectors are doing overall and how they are trading in general. What is the volatility level - are they slow and steady or whipping up and down on the slightest market move? This makes a large difference in not only the stop placement, but in the overall risk level for the trade. Most people assess risk by the amount one can lose when day trading or swing trading. What almost everyone fails to consider is the odds of that loss happening.
While there is no sure fire way to figure out odds, if you watch what other stocks are trading like you can get a pretty good idea. If current conditions are calm, you can usually use a smaller stop amount and still have decent oddsit will not get hit. When conditions are frantic, a smaller stop is almost assured to get hit - meaning the 30c stop has a 98% chance of getting hit even on the exact same name.
The way you figure the odds in a stop happening when day trading is somewhat straightforward. Look at the average range over the last 20 minutes or so, the high to the low area of the bars. Do not pick a very calm period of time, as this calmness tends to lead to increased and unpredictable volatility. If the price action currently is very flat and calm, go back on the chart to a more volatile time of the day or prior day and then figure out the range. It does not have to be exact, an approximation is fine. Once you have measured this range, this becomes your maximum risk.
What the best thing to do is to try to lower the max amount to a much lower level. This can be done 2 ways. The first way is to study the pattern of trading behavior for that stock locallly when it reaches a prior high level - does it normally fade back or does it have momentum and push through? If it starts to push the last few times it reached a high turning point, then it is probably ok to buy the stock on strength. If it tries to sell, or looks like a fade back - wait for it to push and then put your order in at 1/4 of the range computed, but lower than the high its at currently. So if the range was 1.00, and the current price is at around 40 now, you would look to place your order at 39.75 to put on a long. You will most likely miss some trades doing it this way, but have to ignore the urge to chase the prices. If a similar pattern is occurring on a lot of other stocks (in general) you have to be extra careful.
The second way to lower the risk is to split your order into 2 parts. So if your trade size you want is 500 shares, just buy 200 shares now. Wait until the price moves up a decent amount, including past the point where normally they would fade a breakout, and then look to add the remainder on a small dip of 5-15 cents or so. Move your stop up .45 now (assuming you had a 1.00 stop to start) on all of it. The other alternative, if the market tends to fade the push moves, is to buy 200 shares now, then put the balance of your order .25 above your stop price level (figuring it is 1.00). The maximum stop loss level should remain the same on all the accumulated shares. The difference here is if market conditions get poor for going long when day trading for a period of time, you are going to lose a lot more averaging when its selling because you will get filled on the add, then stopout 2 minutes later on all of it.
The way around this is to simply cut back size - when the market gets unpredictable, play ONLY 1/2 normal size or less until it starts to act more predictably. The name of the game is preservation of capital first and foremost (hence the stops), but second its to avoid easy loss situations. While is is very difficult to actually tell that trading conditions are improving without actually trading, it is a very good idea to trade with less shares until you visibly see conditions look better over time.
