Trading Stop Loss Strategy: Tight Stops vs Breathing Room

Steve Nison's Candlestick Techniques
What is the preferred trading stop loss strategy? There are two schools of thought on this. You can use tight stops and take more small loses, or you can give your trades more room to breath at the expense of taking larger loses.  Which strategy should you use?  In this article, I will try to highlight some of the benefits of both strategies, as well as give you some examples on when to use each one.

Whether you’re using a tighter or looser stop loss strategy, you should never risk more than you are willing to lose.  I personally never risk more than 2% per trade. Many traders use .5% – 1% per trade, while very experienced traders often risk 3% or more per trade.

Many traders adjust their stop loss strategies according to how risky they believe the trade to be.  If you have good reason to believe a trade will continue in the direction you desire, it doesn’t make sense to use a tight stop loss.  Instead, you should opt for a little breathing room for your trade.  If you’re less sure that your trade will be a winner, you should opt for a tighter stop loss.

Trading Stop Loss Strategy

Stop Loss Strategy

When to use a loose stop loss – You may consider using a loose stop loss if you have good reason to believe a trade will move in your favor, but it may swing away from your entry point first.  Another thing to consider is the condition of the market.  If market conditions are trending sharply in one direction or another, a tight stop may not be necessary.

What time frame are you trading on?  Positions that you plan to hold for a few days or weeks are usually bad candidates for a tight stop loss strategy.  For investment or swing trades, a little breathing room is usually preferred.

When to use a tight stop loss – If you believe a trade could move in your favor but will definitely continue to move away from your entry point after it reaches a certain price, you should use the tightest stop your trade will allow.  If the market is choppy or has no clear direction, you should use tight stops.  You should also consider not trading in those conditions at all.

If you are doing some quick day trading, a tighter stop loss strategy may be ideal.  You may also want to consider using a tight stop if you are counter-trend trading.  For instance, if you’re taking a long position in a bearish market, you would want to use tighter stops than you could get away with if you were trend trading.

Setting your trading stop loss strategy is an art.  No two trades are the same, and different factors will affect your strategies on each trade.  Ultimately, you’ll have to put in some screen time to see what works best for you.  Getting stopped out is frustrating, but with practice and a good trading system (like Top Dog Trading) you can learn to get stopped out less and less over time.

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