In the pursuit of long-term profitability, you need to become proactive in protecting your funds. Entering a position from the perspective of what you are risking, rather than what you stand to gain is the differentiator between the traders that “make it” and the rest.
- Determining where to set a stop loss:
You are looking for an area, where your trade will be invalidated = where your trading idea is wrong.
Popular options are:
Price invalidation based on Support or Resistance levels – Identifying a price invalidation based on Support or Resistance levels
Stop Loss based on ATR or another volatility indicator – It shows the average volatility for the past 14 bars. The idea behind using it: “I better put my Stop Loss outside the zone of normal volatility to avoid getting stopped by normal market moves”.
Stop Loss based on the trend - There are many ways traders try to identify a trend and its strength. The easiest way to analyze them using Technical Analysis would be through moving averages (MAs). Whether you are looking at the slope of the moving average, its relationship to the price (being above or below the MA), price, or another moving average with different settings crossing it (fast and slow MA cross combinations) – all of these options can help you determine the trend direction.
Fixed PnL Stop Loss - This is generally not a very efficient way to place a Stop Loss, because the market doesn’t care what % of your account you are willing to lose. If you’re for example always opening a position with the same size and using the same, say 2% stop loss, it will get placed on price levels with no regard to the previous market movements, volatility, or anything else but your balance. This can lead to you getting stopped out a lot, even though the underlying signal might be good.
Trailing Stop Loss - This dynamic way of setting stop losses follows price. If you set a 5% trailing stop loss and the price keeps going up, the stop loss moves up with the price. It can be useful in trending markets or when the asset enters price discovery and traders don’t have known price levels to work with.
- Stop loss order types:
Limit orders - set a specific price and can be executed only at that price.
PROS:
In crypto: Limit orders tend to cost less than market orders as they are considered “market-making” (Maker Fee)
It guarantees the execution price
CONS:
This stop loss can be set off only if there’s an equal or bigger buyer at that price. You risk not getting your full position closed.
Market orders: set to trigger when a certain price is reached, but will execute until full position is closed – even if it means slippage (“eating through the order book”).
PROS:
It will close your full position
CONS:
The actual execution price may vary (due to slippage = defined by volume and how thin is the order book).
In crypto: Tend to cost more (Taker Fees)
Stop Limit orders - There can be even more niche categorization of limit orders.