Monday, December 15, 2014

Tight stop losses vs wide stop losses

When should you use a tight stop loss versus a wide stop loss? 

The definition of 'tight' or 'wide' is subjective, but I personally define a 'tight' stop loss as anything 5 pips or below (if trading intra-day). 

A 'wide' stop loss can be bigger, and is usually placed at a strategic location like a swing high or low, or a S/R level. A 'wide' stop loss can be further widened with a buffer to allow more 'breathing space' at a S/R level, in order to give S/R a chance to work. 

These are my thoughts. My preference has been towards using tight stop losses for intra-day trades. 

(I may expand this list later as I develop new thoughts)

When to use a tight stop loss 

- you are aiming for a high reward:risk ratio (i.e. over 2:1)
- you want to be out of a trade quickly for psychological reasons (the longer a trade takes, the more opportunity there is to make sub-optimal decisions)
- you expect the trade to move in your favour quickly and decisively (if price action is indecisive, you want to be out)
- you've already received signs of confirmation for your trade (e.g. if trading a trend, the trend should already be under way)
- you expect price to be one-directional with low probability of choppiness or a major pullback (e.g. a major trend, a breakout, a stop hunt, news release etc)
- you're comfortable with being wrong
- you prefer lots of small losses and the occasional big win
- you want to move the trade to breakeven as soon as possible
- you believe that winning trades should move in your favour quickly
- you trade low-probability setups
- (if trading intra-day) you like to trade volatile hours where spreads are tighter and you can get one-directional moves (e.g. London Open, London / NY overlap, Tokyo Open) 
- you trade a major currency pair with tight spreads, such as the EURUSD or USDJPY

When to use a wide stop loss

- you are aiming for a moderate reward:risk ratio (1:1 to 2:1) (larger R:R ratios are acceptable for longer-term trades)
- you believe that price may be choppy after your entry (e.g. a ranging market)
- you believe that your price forecast is correct, but you're unsure of your timing
- you'd prefer to be right
- you're comfortable with leaving trades open
- you are fading a move without confirmation (e.g. using a sell limit order to enter as price moves to the top of a range. A wide stop loss beyond the top of the range will give price room to 'breath' and turn in your favour)
- you prefer an even mix of wins and losses
- you manage your trades passively and like to walk away after entry
- you trade currency pairs with wide or fluctuating spreads
- you trade during quiet market hours where there's less market direction

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