Among the most common and expensive mistakes, traders make, moving the stop loss on a trade to break even too early. Psychologically, it is attractive to move a stop loss to break even to enjoy the feeling of removing risk. However, it’s often not a smart thing to do as it usually results in being kicked out of potentially profitable trade too early.
Traders should only move either after a defined period has elapsed or after the trade moved in the trader’s favor by a large amount, compared to the trade risk. Other methods of judgment typically produce poor results.
The question if traders should move a stop or not, and when they will move it, depends upon the style of trading – i.e., the tolerance for losses and profit targets.
The Statistical Reality
Try to look at the trade entries or most entries generated by a strategy. Traders will notice that in most cases, the price goes back to the entry level, even after a relatively considerable period has elapsed. Even if a technical development happened indicating that the price is not going to come back there, for instance, carving out a higher swing low or lower swing high, it might still return and hit the newly breaking-even stop loss.
Approaches in Adjusting Stop Losses
- Defined Time Period
Waiting for a defined length of time – one that should have given the trade enough time realistically to breathe – is an approach that can work. When the time has elapsed, if the trade shows a loss, exit immediately, but if it’s a profit, move to stop loss to break even. When traders apply this method consistently, they could save in early exits from bad trades what they missed in early exits from trades that turn out to be good trades.
- Floating Profit
Traders could apply the maxim ‘don’t let a winner turn into a loser’ by changing the stop to break even once it has made enough to be out of the orbit of the entry level. They might be best served if they wait for the trade to be in profit by at least three times the amount of the stop loss before doing this.
- Trailing Stop Loss
Though this can work, it should not be applied until the trade is in profit by at least three times the stop loss, and the size of the train must be based on volatility.
- Technical Stop Loss Adjustment
This has been a general approach – typically involves waiting for any of the following:
- A failed retest of the entry point
- A significant higher high or lower low, confirming the entry
- A triumphant breakout in the direction of the trade
- A failed breakout against the law of the trade.
Though these can work sometimes, it won’t do that often – especially in intraday trading.
- Fixed Pip Amount of Profit
In this section, the stop loss is moved to break even after a few fixed amount of floating profit has been reached. But this is a bad idea, except the price is much closer to the profit point than the entry point.
