Swing Trading Without Stops Is Suicide

July 17th, 2009 |

Author: debt_sol

Figuring out the proper stop loss when day trading, whether experienced or novice, is always a tricky subject. One thing is for sure, if you don't use a stop loss and try to become a trader, there is almost a 100% chance you will lose 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. Additionally, adding to positions in front of economic data to be released or other unpredictable events can assure higher odds of getting stopped out because of increased volatility post release.

The major thing to concentrate on is the current market conditions - this is very important. Not what the Dow Jones Average is doing, it is what many stocks are doing overall and how they are trading. What is the general volatility level for the day, is stuff trading slow and steady or are they whipping up and down quickly on a slight move in the futures market? This makes a huge difference is not only your stop, but the risk level involved. Most people assess risk by the amount one can lose when day trading or swing trading. What most people fail to think about is the actual 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 more volitile conditions are present, using a smaller stop is a really bad idea because of the significantly higher odds that even a smaller than normal oscillation in price will hit your stop.

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 need to be an exact amount, we are just looking for an approximation. Once you have this range, that is 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 accomplished in 2 different ways. The first way is to watch the pattern of trading behavior on the chart of the day traded stock - when it reaches a prior high level, does it push thru and run some, or does it bearly touch, then retrace (sell) down? If it tends to push (last few times it reached a high turn point), then its 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 stock was at 40 now, you would put your order at 39.75 to go long. You will most likely miss some trades doing it this way, but have to ignore the urge to chase the prices. If the pattern is on a lot of names (by eyeballing) you have to be especially careful.

A second way to remove some of the risk is to split your entry order into 2 different parts. So if your trade size you want is 500 shares, just buy 200 shares now. Wait until it pushes a decent amount up (meaning it has pushed enought that it has moved past the fade the breakout move area), then look to add the other 300 on a 5 or 10c dip. Move your stop up .45 now (figuring you have a 1.00 stop to start) on all of it. The other choice if the price tends to fade after pushing higher is to buy 200 shares now and then place the balance of your order .25 above your stop price level (figuring it is 1.00). The max stop remains the same on all 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.