A Swing Traders Stop Loss
In the last blog post, we talked about how channeling stocks can be a great strategy and is one of our favorites after trying dozens of strategies and over 10,000 live trades over more than 15 years. At the end of the article we also gave a recent example, ABNB, that just reached a good entry point. In this article, we talk about where swing traders might place their stop loss.
We said we wanted to see a quick pullback on ABNB before entering a trade in the last blog post for a better risk/reward at this point.
After the blog post was published, the price pulled back to the technical entry point, found strong support there on the re-test, and then took off a couple days later. ABNB quickly surged about 12% from the ideal technical entry point in the pattern while not pulling back hardly at all. A great start to a swing trade.
In our free swing trading primer, we talk about the importance of taking profits in that first 5% to 15% profit area and then raising our stop to nearly ensure a profit. In this case, a good exit point was a little below the next level of resistance which was near $150.
12% is a great profit within just a few days and its important to take some of those profits when we can.
Here is the latest chart:
Charts courtesy of StockCharts.com
Swing Trading Stop Placement
One of the reasons we liked this trade so much is we had a long, narrow consolidation just above the uptrend support line. We can place a hard stop just below this narrow consolidation as one option for a good swing trading stop loss.
The reason we choose this stop point is that more buyers have stepped in near the low in the consolidation in the recent past to overwhelm the sellers and push the price back higher. This has occurred multiple times to let us know this level is the “floor” currently on the price.
This is was what a support level is. Its just the actual point where buyers have stepped in to generate enough buying demand to send the price back higher. Prices move higher because there are not enough shares available at the current price to sell.
The inventory at that support level in the consolidation vanishes as the price approaches the low and you have to find more sellers at a higher price as more buyers step in and/or sellers back away.
This could be due to just fluctuations in the overall market but when the price of a stock finds support at a given price 3 or more times, it becomes clear that the support price is more meaningful to investors and traders.
Getting the Math Right When Swing Trading
Knowing where to place your stop has a lot to do with the expected gain if things go well. In this case we can see the next level of resistance is around $150 on the chart. So we can place a limit order to sell just below $150. Say $149. This is about 12% above the entry point.
If we have around a 1.5/1 reward to risk ratio, then for a quick in-and-out trade, we could use an 8% stop. This 8% stop lines up real nicely with a level just below the low in the consolidation. Around $123.50.
So ideally, we want our stop just below a confirmed support level such as the one in the chart above.
If we have about a 55% – 60% win rate historically, we would have a positive expectancy on a trade like this. Its also very nice to get in and out quickly for a 12% profit and look for the next ideal trade in a strong market. Fortunately, it reached the next level of resistance within a week and a half.
12% does not sound like much but using the rule of 72, 12% per trade would double your account every 6 trades when compounding if we can get 6 winners in a row.
Of course, a 60/40 win rate brings the average to 3.5% which doubles your money every 21 trades using the rule of 72 when compounding your gains. Finding trades that will resolve quickly is very important as well which we will cover in a future blog post on how to build a small account quickly.
The goal of swing trading is to increase your win rate over time by honing your strategy, reviewing your trades consistently, analyzing your tendencies and cleaning up more mistakes over time to increase your win rate and average profit per trade on trades that hit the target as quickly as possible.
Another goal is to be sure to find the highest percentage swing trading opportunities consistently. In a recent back-test, the high tight flag strategy that met all of our rules the morning before they broke out, had an extremely high win rate in 2023. More on this in a future blog post as well.
Why Stops are Important When Swing Trading
We need to ensure that we are making progress over the longer-term in our swing trading account. For most traders, one of the key things they can do is to raise their swing trading stop loss while using their limit order to ensure they take profits when they should.
So if you are using a 8% stop-loss lets say, be sure to have a limit order in place to take profits around a 12% profit. So even if you win 45% of the time, you should still be profitable overall if your overall trading account risk is 2%.
And its extremely important to track how well similar technical patterns are performing in the current market. Over the past couple years, among other things we have been stressing the importance to customers of taking more off in that 5% to 15% profit range while tightening your stop. This is because the market environment was such that stocks were more limited to their upside.
This temporary tendency has been shifting to an expectancy of a larger move from a good technical entry point as a new market uptrend develops.
Setting Stops When Swing Trading Options or Penny Stocks
Now lets say you are swing trading penny stocks or options and your stop becomes 20% per trade going for a 25% profit. A better 5% differential versus the 4% above.
In this case, if you are profitable 45% of the time, you would actually lose about 10% over 20 trades. So you take a profitable strategy and turn it into an unprofitable strategy just by widening the stop and profit target while still making 5% more on the winners than the loss on the losing trades.
The problem gets worse when you consider that every back-test we have done shows a significantly lower win rate with penny stocks and stocks under $20 over the long-term.
With options, the option loses value each day (and during the day) as you get closer to options expiration. So if the price of the underlying stock remains constant along with volatility, the option value goes down as you get closer to expiration. This, of course, lowers your win rate as well.
With penny stocks you also have the added risk of halts. I have yet to see a stock I am trading in a multi-year uptrend over $20 get halted and re-open more than a few percent lower.
However, it happens all the time with penny stocks. Recently we have seen multiple penny stocks being touted online by seemingly reputable penny stock experts get halted and re-open much lower. One re-opened down 90%. Once its halted, you cannot sell until it re-opens for trading.
This makes risk management when trading penny stocks very difficult at best. Add the lower win rate overall and even the right stop-loss strategy gives most penny stock traders an uphill battle to be profitable when trading long. This is why we stick with the best young growth stocks and UPOD stocks.
Stop-loss Strategies We Use
We always go into a trade knowing where we are going to get out if it goes against us. This is crucial when trading. One big loss can crush your returns over a quarter. Stopping out is part of the game and something you must do to stay in the game long-term.
Staying in the game is required to get the necessary experience to become a very good swing trader.
With one of our favorite technical patterns, we know we are getting out at a 2.5% to 4% stop-loss with a very high probability of the stock going at least 7% before then.
One of the best risk management strategies is to pick great trading opportunities to begin with in a market environment that is good enough. Not perfect, just good enough which is most of the time historically with our favorite breakout strategy.
Stop-loss Discipline
So this means if it reaches that 4% stop, we are back in cash. If it reaches the target, we can take most of it off and let the rest run while raising the stop to break-even on the remainder of the position.
So many of these patterns are coming up currently, we want to get into the next ideal trade so it may be better just to take most of the profits and look for the next trade. Many hundreds of them are suddenly setting up currently, in fact, which is about the most we have seen.
Over the past year, 80% of them hit the stop or first profit target within 2 days which is similar to what we saw in prior studies with a very high win rate when using the rules in our course at the breakout point. The ones that do not meet the rules at the entry trigger have a less than 50/50 win rate.
So using the typical approach with this bullish breakout pattern, the win rate is much lower. Or, you have to use a much wider stop-loss which becomes a problem as outlined above with widening your stop.
We know the ideal stop because we have studied hundreds of these breakout patterns and have over 15 years experience trading. So we know where to put our stop with a high probability of success when all the rules are met the morning before it reaches the entry trigger.
So study hundreds of examples of the technical patterns you are trading in both bull and bear markets to determine a good percentage stop-loss to use that achieves a positive expectancy over the long-term. You can even use the average true range of the stock to determine the ideal stop point with each trade.
Sometimes, a simple 2.5% stop on stocks over $20 is best while holding the stock for a couple days to see what kind of start it gets off to.
Swing Trading Stop Order Types
Because we trade the best growth stocks and stocks beating estimates with rising future expectations over $20, we often use a “mental stop” when trading along with a price alert with our online broker. If the price reaches the stop with no news, we may keep a portion to see if it rebounds before the close or in the days ahead.
Most technical traders do not use the advantage of stocks with rising estimates in great long-term trends, so usually its best to put a stop-loss order in with your online broker.
Some may choose to use a “stop-limit” order where once the stop price is reached, your online broker puts in a sell limit order. This means the stock will not sell unless you at least receive the limit price.
The problem with this approach is that the price may continue to fall and not come back to the limit price. As experienced traders, we know some trades will win and other trades will be losers so its best just to get out immediately on a breakout trade. This usually gets us out very near the stop price.
Swing Trading Trailing Stop Loss
With one of our favorite technical strategies, we use a trailing stop-loss once the price goes 25% to 30% higher which usually happens within the first week or so if it does on the most bullish technical pattern. You can just put the trailing percentage stop-loss in with your online broker once it moves 25% higher and the stock will automatically sell once the powerful trend breaks.
Then we see how it consolidates to see if we have another ideal technical entry point. If one does not come up that meets our strict rules, we are trading another ideal explosive breakout. Its that simple.
In Summary
One stop-loss strategy is to not even enter a trade that is less than ideal. This alone will save you a lot of losses. Chasing stocks does not work long-term.
Identifying great trends, a good consolidation pattern and then good technical entry point with a catalyst works much better in our experience. These can often be traded with a very positive expectancy in most market environments such as the one we are in now.
Knowing exactly where you are getting out if the trade goes against you is required when trading. We always know where that is and our first profit target before entering the trade. Both need to make sense in terms of historical tendencies for the technical pattern and type of stock we are trading. The risk/reward and win probability needs to make sense as well.
Stop-losses are like insurance policies when trading. One big loss can take away a lot of other profits so its required before taking on a trade if you want to be successful long-term.
Using stop-losses also gives you more peace of mind when trading. Its important not to waste time and emotional energy fretting over a trade going against you. Plan ahead and just cut it once your stop is hit. You will have plenty of big winners as well in your trading career if you are using a great strategy that is well researched ahead of time.
Using a limit order for your target profit, often just below the next level of a resistance on a daily chart, will ensure the math behind your trading makes sense looking at your risk/reward ratio. This is because you automatically take profits at the target rather than forget to sell around the profit target.
You can only take profits when you have them, not necessarily when you want them. A sell limit order ensures you take at least partial profits and are cued to raise your stop on your remaining position.
Also, trading with a big, fresh catalyst often allows you to just put a tighter stop-loss just below the technical entry point on a daily chart with your limit order that is well researched ahead of time.
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