After you have entered a trade and entered a stop loss order, your stop needs to be adjusted to lessen the amount of money you have at risk and to protect larger amounts of profit. It is mandatory that you move your stop only in the direction of the trade, and do it quickly. To do otherwise is indulging in fantasy and false hope. We have seen too many traders moving their stop back to “give the trade a little more room.”
Shortly after you enter a trade, you should quickly enter a stop loss. When entering a long trade your stop-loss order should be placed below the most recent support level if you can afford it. If you can’t, settle for a smaller stop, or do not enter the trade at all. When entering a short trade, your stop- loss order should be placed above the most recent resistance level if you can afford it etc.
As the trade progresses, think about moving to a break-even stop-loss as soon as possible. If break-even holds, consider moving your profit protecting order to protect at least half of your open profits. Do this as soon as you are able.
Using Mental Stops
Many traders prefer mental stops for protection. Some traders feel that by having a stop order resting on the floor, they are vulnerable to a run on their stop, and in some cases, they are correct. They are correct in this belief if they are trading in a thin market.
However, the criterion for whether or not to use mental stops is a function of your discipline, not of whether or not your stop will be run. What follows in the next 3 paragraphs is the typical wrong thinking about the use of mental vs. physical stops.
“If you want to use mental stops, you need to be aware of the amount of slippage that occurs from the time you decide to place an order until you receive your flash fill. Check the time it takes to place a market order on a number of occasions and average the number. If it takes one minute to get your fill, then see what dollar range the current 1-minute bars are on your chart.
“This dollar value will be your probable slippage. I say probable because in some market conditions, price can move very rapidly against your position and with no stop in the market, your trading account could suffer accordingly.
“In any event, if the amount of slippage that occurs between the time you decide to make a trade, and the receipt of your flash fill is comfortable for you, then by all means use mental stops. However, if you are subject to interruptions during your trading, or if you are easily distracted, I advise against your using mental stops.”
What is it that is incorrect with this kind of thinking??
Let me begin with a simple statement: If you do not have the discipline to use mental stops, then do not use them. Mental stops are for people who will not flinch in exiting when it is time to exit. They will not hesitate. If that’s not you, then be sure to use physical stops.
Now, what about this business of: “They’ll see your stop and because they see it, they will try to run it.” Hogwash! They are always going to run the stops at support and resistance, whether yours is mental or physical. The less liquid the market, the more easily the stops can be run. The more liquid the market, the more difficult it is for the stops to be run. But sooner or later, they are going to run the stops. Do those who are able to run stops know where they are? You can be sure they do! They know where support and resistance are, same as you.
Will they be gunning for your stop? Just who do you think you are with your 2-3 contracts? The reason for staying in liquid markets is that in those markets, no one is going to come looking for your 2-3 lot. The only way ever to be in a thin market is if you are in a spread trade. There is no stop running involved with a spread trade.
Now then, what is all this garbage about slippage using a mental stop? Here are the facts, and they have been tested by dozens of traders over thousands of trades:
If you enter the market as soon as you are able once your mental stop is hit, it doesn’t matter if it takes 1 second or 1 minute – sometimes you are going to exit with a few ticks more of loss, but sometimes you are going to exit with a few ticks more of gain. Markets tick up and down, not only in one direction. The truth is that overall, you will come out the same whether the stop is resting in the market or you enter the exit order when your exit point is hit.