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Trading Dilemma: Should you move your stop-loss?

Jul 14 2017
By
Jonathan Smith

This article will focus on the topic of moving your stop-loss order in the profit, once a trade has gone in your favor. This is a complicated subject and there is no one clear way to look at things. We would aim to provide you with multiple points of view and most importantly food for thought. 

 

Should you do it at all?

 

First of all should you even move your stop-loss after it’s being placer? You should definitely not move it further away from your entry point (widen it), as this defies its initial purpose. This is a classic beginner mistake, which doesn’t require much explaining. When it comes to moving your stop to break even or a profit, things aren’t as simple.

 

One approach is to never adjust your stop-loss. This essentially turns your trade into something similar to a “binary option”, in which you determine the conditions. The market will eventually either reach your stop or your take-profit level and you will be out. Though this may sound great in an ideal environment, the picture is slightly different in real trading conditions. No matter how experienced of a trader you are, psychological factors will affect you once you are in the market. 

 

What will happen if your trade has moved 50% of the way to its target, and you suddenly hear a news story, which suggests a move in the opposite direction? Will you still leave your trade intact? Will you close it in a panic attempt to preserve at least a portion of the profit? 

 

We believe, you should have a methodology of doing things when trading. This applies for moving your stop-loss.  Let’s take a look at some of the possible approaches.

 

Several approaches 

 

After a certain market move

 

The most basic approach is to move your stop-loss after a certain price move in your direction has already occurred. Lets say you decided to risk 100 pips to make 300. The market has moved 100 pips in your favor and is beginning to stall. If you follow this approach, you may want to place your stop-loss at a 70 pip profit, for instance. You would still catch the next leg in your direction, if it occurs, but you would also catch a significant amount of the current move, if the price decides to retrace.

 

The tricky part here is to follow the price action. Look at previous levels of support and resistance and don’t just blindly place your stop as near as possible to the current price. The 70 pip profit level, in the example, was intentionally chosen over a 90 pip one.

 

After a certain period of time

 

The second most common way to look at this dilemma is to adjust your stop after a certain period of time has passed. To use the example from above, the marked has moved 100 pips in your favor, then it starts trading in a 20 pip range for two days. This may be the point where you say to yourself, “The momentum is gone, I better guarantee my 70-80 pips before the pair totally reverses”.  Again do be sure to leave some room and not place your order at the exact end of the range.

 

The key aspect of this approach is to not focus too heavily on the lower timeframes. If your set-up originated on the daily chart, wait for at least a few days of market inactivity before moving your stop. If you decide to to do so after a few hourly bars against the trade, you are very likely to be stopped out way to early.

 

Splitting your position

 

This is another commonly used technique.  If you have opened a trade with, for instance 10,000 currency units (or 0.10 lots in MetaTrader4), it may be best to simply move the stop-loss on 5,000 of them at a profit. If the market happens to reverse, you would still close a partial profit, which would negate a potential loss with the second part of your position. There are many variations of this strategy, with some advising further splitting in to three or four parts.

 

Statistical implications

 

Another aspect of moving your stop-loss is the fact it has implications on your track record. If you always trade with a 1:2 risk to reward ratio, or greater, but you are always closing your trades when you reach a 1:1 level, you are not really following your system. When revealing your results later on, you may see you have an 80% winrate, but somehow end up with less profit than the period you had a 60% winrate, with “the same” strategy. You should have a system which distinguishes between “early winners”, “brake even trades” and “winners, which have reached the initial target”.

 

Other than the purely statistical implications, moving your stop will limit the size of your winning trades, but increase their number. This can have positive as well as negative implications on your trading results. There is no clear way to say, doing X this often, will create Y in terms of results. Your analysis should be able to provide you with this information, for your particular trading system. Although some traders are more comfortable with picking-up small winning trades often, than with having one massive winner and a lot of small losses, both ways of operating can yield significant profits.

 

An example

 

Let’s take a look at a practical example of all of this. You see this EUR/USD daily chart (click to zoom-in):

 

 

You then realize, based on other analysis, we are likely in for a more serious move to the downside. You short fort 10,000 units at the close of the latest candle (1.12693). You place your stop-loss at 1.13693 – the red line) and are waiting for a 3:1 move to 1.09693. We have noted several 100 pip zones with blue lines.  Here is what happens several days later:

 

 

After an approximately 100 pip decline the pair is slowing down. While only the latter two candles ate positive, the two previous ones have also not been very strong, in terms of bearish momentum. Now you are in for a decision: Would you place a stop-loss order above the high of the current bar? Would that stop be for your entire position? You may also want to place the stop at break-even, the higher blue line. You may of course want to to “let it ride”. 

 

Although the idea of this exercise was just to get your head moving around the variables, we know you want to see what actually happened (and what your result would have been). Here it is:

 

 

Some of you may be disappointed, while others will be satisfied because the played it safe. This is just one example, so don’t blame yourself if you got it wrong. The idea is to learn how to think in these circumstances, when they arrive in your real trading.

 

Aren’t trailing stops a better solution?

At this point some of you may be wandering, how we haven’t mentioned trailing stops already. Virtually all trading platforms nowadays provide this functionality. A trailing stop is a stop-loss order, which follows the current market price, as it moves in your favor. For instance, if you buy a currency pair at 1.1000 and set a 20 pips trailing stop-loss, it will initially be placed at 1.0980. Then if the market moves to 1.1010, the stop will go to 1.1090. This may appear to be a perfect middle-ground solution, but in reality there are some issues with trailing stop-losses. 

 

The biggest one is the fact, a trailing stop may end up at an insignificant market level. In all of the examples we have given so far, the presumption was that the market had entered a consolidation. Then you would judge where to place your stop-loss after a careful analysis of the price action. In the case of trailing stops, this is not the case – they are an arbitrary number, which you have assigned, when placing them. That being said, a trailing stop can do you wonders if there is a serious market spike in your favor, which later retraces quickly. 

 

Conclusion

 

Moving tour stop-loss order in the profit zone is tricky. The essence of this dilemma is similar to the one you face, whenever deliberating to simply close a trade early on or “let it ride”. Would you like to have multiple small winners, or fewer but bigger ones? Both ways of looking at trading can produce results. Most new traders should prefer the more defensive route, as the first step towards making a profit is to stop loosing. On the other hand, limiting your the size of your winners can be even more frustrating than having a loosing trade. Although there is no one right answer, to this complicated issue, hopefully we have provided you with some food for thought. 

TAGS: stop  stop loss  stop-loss  move your stop loss  trading  dilemma 
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