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Today’s Whiteboard Wednesday will focus on setting trading stop losses, the different types of stop losses, and the how to do so the right way, the Lincoln way.

As we’ve discussed before, you have to develop a trading system of letting your winners run and keeping your losses to a minimum. How you do so will be totally up to you. But no matter what strategy you use, you can’t be taking small win after small win, only to see those tiny profits be wiped out by huge losses.

Day Trading Stop Losses

First, let’s talk about what NOT to do. Do not set hard stop losses where everyone else sets them, which usually is around round numbers and what I call half numbers (.50’s). Your stops will get hit by the market makers and new algorithms (algos) who are specifically designed to sweep these stops. Plus, you will watch in anguish as the stock moves in your favor after you have been stopped out.

Now lets discuss the three different types of stops we use in our trade services, which are:

  • Hard Stop
  • Time Stop
  • Mental Stop

Hard stops are very common and can be used by placing a stop limit order or a stop market order with your broker. I probably use hard stops more than most folks in our room. And I use them in different situations with the most common being the “now or never approach”. This approach occurs when a stock is acting right and then all of a sudden stops. It will test support or resistance multiple times before it begins to pause. Your patience begins to run out so you put in a hard stop in place just in case it reverses , it is “now or never”. So you protect your profits.

Similarly, a time stop is when you take a defense first approach. If the stock you are in isn’t acting right after you have given it ample time to work you need to cut the trade. This is an emotionally tougher stop to use because you feel as if you are giving up hope. However, you will find out that the longer it takes for a trade to work, the less you stand to gain from it.

And then there are mental stops. With mental stops you are not placing an actual order you are trusting that you will know when to exit your trade  Sounds good in theory, but you have to be disciplined, otherwise what is the point of having a mental stop if you are not going to stick with it?

Finally, if you are going to use mental stops, don’t exit when the stock touches your price. Market makers know and see where everyone has their stops. Even if the stops are not around round numbers. What I do is watch if the stock builds over or under a certain level. Imagine you want to short a stock at $10. How many times have you seen the stock touch 9.97 only to see it bounce to 10.10. But if you see it build under $10, 9.97,.9.95,9.99,,.9.85, you can start setting a mental stop above 10 or even 10.10.

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