For chart pattern trading (I learn and read up particularly a lot from Peter Brandt, peterbrandt.com), near the failure of the chart pattern formation or breakout point will be your stop loss. I like to lump chart patterns eg Head and Shoulders, Cups, Triangles with trading on support and resistance lines… So similarly…the failure for R/S lines will be the stop loss level.
Here is a screen shot of a good H&S initial failure then follow by a good breakout, a double bottom, and a rectangle trading range formation with good examples of whipsawing breakout failures…can you see?
If you like to buy on “dips” or “pullbacks” or “flags” etc during an uptrend (actually, Elder’s Triple Screen is a very good set up for trading this style), then the prior mino low is your stop loss level.
See the below? The 1st blue circled entry was not stopped out….but the 2nd one is…can see?
The 5 steps or questions are quite interlinked…stop loss helps me dictate how much to buy too…not just an independent step on focusing out stopping out…
So now the last stop (sic…..hehehhe) that I am familiar with….stops based on trailing volatility. There are many tools to help, eg Standard Deviation or Bollinger Bands, ATR, Price Channels, MA Channels, % Change etc….
Basically, you are using the specific volatility or average price movement of the particular counter to dictate when the current movement is too much, based on the average movement of the past. A bit chim huh?
Sorry ah, I lumped all the channels indicators avaliable to me here 🙂 Purple is bollinger bands, green is MA Envelope, Yellow is MA Channel and Blue is price channel. All are all different forms of price movement or a form of volatility on average for the counter.
For example, lets say we use MA envelope here…stop will be at 3215 (somewhere there la). So incorporating our position sizing step and if our entry is now at 3285, units to buy is based on amount to risk / (3285 – 3215) = amt to risk / 70points.
So how do we get this amount to risk? I have actually detailed this in “Maximum Drawdown”…. a lot of us around like to use percentage of capital as a guide. (Alexander Elder advises 2% max per counter, and total 6% current open position exposure….)
Lets say we have a trading capital of $50k, and would like to risk 1% (for me, based on my personal backtesting and comfortable maximum drawdown of around 10%…risk per trade it will be around 3%), so that will be $500 / 70 = 7 units or contracts or shares to buy etc…
I like this method as a stop near the extreme end of the volatility means I dun get stopped out by unnecessary market “noise”…. of course you have to choose our parameters yourself….the period to measure and the units of risk etc… Once again…a bit vague here (intentionally) you have to do backtesting to test the best numbers for your system. Im trying to highlight to you about stops…not my actual trading system here :p
…Of course, there can also be sudden changes to initial moves. These cases normally reverse or stop out my positions but losses are part of the business and they are normal. It is important to trade what you see and not what you are convinced of as convictions are often misleading…Losses are normal; there is nothing wrong in positions getting stopped out. You need to see the long-term picture in the context of your trading approach and view losses as costs of the business you are building….Andrea Unger
The last of the 5 steps is next…