Stop-Setting

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A reader sent me an email which asked: “I have a question about stops…once before you mentioned that you limit your losses to think 1-5% using stops. How do you decide whether its 1%, 2% or 5% etc? And can I assume that some of your losses are very small numbers like $150 and some are thousands of dollars?

As I’ve tried to say before, I avoid responding 1-on-1 to just about anything, so I told the gentleman I’d write up a post about this topic. So here are a few points, in no particular order, about how I set stop-loss levels:

  • Some people use stops, and others think they are lunacy. If I only traded options, for example, i would probably agree with this to some degree. However, as a lowly swing trader, I really insist on having stops on every single position at all times.
  • I am not looking for some magical dollar or percentage figure as the basis for setting stops. This is a two-step process. First, I determine which price level would have to be violated to wreck my rationale for the trade. In other words, what is my “get out!” point. Second, based on that, I will determine the size of the position based on a reasonable dollar amount I’m willing to lose. Thus, if the stop is rather wide (like, say, 6%) I’ll have a tiny position, whereas if it is 1.5%, it will be much larger.
  • These days, I am tending to round up the stop-loss prices to the nearest nickel. I do that for a couple of reasons. First, some stocks have nickel-wide spreads, so I have to do so. Second, I don’t mind giving my positions a few pennies of wiggle room.
  • Finally, I keep my stops fresh. I’ll update every single one of them every few days, and I’ll tighten up positions which have moved in my favor as frequently as necessary to keep the percentage difference between present price levels and stop-loss levels reasonable.
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