Suppose you are a day trader and you bought a stock recently that you thought will rise in value and then you can sell it off to book a neat profit. But before you know, things begin to go south, and you are staring at a loss. How much damage are you willing to assume before you know it was a wrong buy decision? Placing a stop-loss order helps you contain your losses. But is there a chance you can be too cautious and ruin your chances at making a profit when prices start rising again? Possible. That is why it is so important to have the right stop-loss strategy in place.
Day Trade Stop-loss Order
You can assign a stop-loss order to your broker to sell and get out of a position when the stock reaches a specific price point. With a stop-loss, you get to control how much you lose on a particular trade. And so it becomes essential to place a stop loss at the right point, so you do not make too conservative or too risky decisions and end up not profiting. Stop-loss also allows you the luxury of passive trading. That is, you do not need to monitor your trades all day. If you are on a vacation or holiday, you can let the stop losses take care of your deals. On the downside
The Percentage Rule
Some traders believe in determining a percentage of loss. For example, an investor may choose to place a stop-loss order at 10%, that is the stop loss will be triggered when the stock price reaches 10% below the buy price. This is one of the popular stop-loss strategies. Let us assume; you bought the stock of company ABC at Rs.100 per share. You placed a stop-loss at 10%. When ABC shares decline enough to touch Rs.90, the stop loss would be triggered, and your stock would be sold off at Rs.90 to prevent further losses.
Support and Resistance: Knowing you are headed in the Wrong Direction
The idea of placing a stop-loss is not so much about being too overly cautious and not taking risks at all but when rightly placed it acts as an indicator that you may have misjudged the direction of the price movement. And if you do not exit at this level, you stand to make more losses. This is why a 10 percent rule helps give some manoeuvring space for stock prices to recover after a fall.
Support: Stop loss below the swing low
Another strategy suggests, when you are buying a stock, place the stop loss right below a swing low. Swing low is the lower price band off which the prices bounced back and were followed by the next consecutive higher lows, making a V-shaped movement. When prices fall below the stop loss level, in this case, you may likely have got the direction of the market wrong, and irreversible.
Resistance: Stop Loss above Swing High
Similarly, when you are looking to short-sell, place the spot loss above the swing high, a point where prices bounce off and are followed by next lower highs like an inverted V shape.
Investors also apply moving averages to their stock charts to arrive at their stop loss targets. Moving average is the representation of averages of daily stock prices over various periods, say 15,30,50 or 100-day moving averages. You can place stop losses below the moving average level. Here it is essential to use a relatively longer-term moving average so that you do not place the moving average too close to the price at which you bought the stock. In which case, you may end up exiting the trade too early, before the stock even got a chance to recover.
Choosing the right day-trading stop-loss strategy is critical because it can break a trade your way or cause loss of opportunity.