You enter into a trade and place a stoploss. Market goes against you, takes your stoploss and reverses again to hit your target. Does it happen with you again and again?
If answer is Yes, then you should read this. I will tell you why exactly this happens and what can you do for it?
Just remember that market is not going to go up as soon as you buy the stock. It is going to fluctuate back and forth in both the direction before it actually move substantially in your direction so when it fluctuates against your position, you should keep the stoploss far enough to give that SPACE to price to move against you.
You should place the stoploss far enough to give room for the prices to move in either direction.
If you place stoploss too tight, it is going to take your stoploss before it reaches the target.
Most of the traders place stoploss at an incorrect level.
The stoploss should be place in such a way that when it gets hit, it should confirm that your call has failed completely...
The typical way in which traders place stoploss is as follows:
1. Stoploss in rupee terms i.e. they place stoploss when the loss reaches a certain amount say Rs. 1000 per trade. As soon as the trade reaches 1000 loss, they exit. This is incorrect way of placing the stoploss.
Suppose you buy 100 quantities of a stock at Rs. 500, where would you place your stoploss to make Rs. 1000 loss?
10 points away. At 490 right?
Now say, instead of buying 100 quantities, you buy 200 quantities. Where would be your stoploss.
It would be 5 points away, at 495.
Is 10 point stoploss same as 5 point stoploss?
Is possibility of hitting a 10 point stoploss same as 5 point stoploss?
Now if you decide to buy 20 quantities and to incur loss of 1000, you will have to place stoploss 50 points away. Won't it be too far?
So this is the problem with constant rupee stoploss...
You will, in most of the cases end up placing stoploss too tight or too loose and that is the reason that your stoploss gets hits again and again
2. Another typical stoploss that people place is constant percentage stoploss. They place stoploss at a certain % of current price. For example, 2% away from current price so if they buy at 500, they will place stoploss 2% away i.e. 10 points away. If the stock is values at 100, they will place stoploss at 98 etc.
Now this may seem to be very logical way of placing stoploss but let me tell you that it is flawed
ALL THE STOCKS ARE NOT EQUALLY VOLATILE
An FMCG stock for example HUL is less volatile than TCS (an IT stock). 2% in HUL would be too much while for TCS, its not a big deal. TCS being more volatile needs to be placed a bigger stoploss as compared to a stock which is comparatively less volatile.
If you use constant % stoploss, you will end up placing a tighter stoploss on highly volatile stocks like telecom, IT, banking, financial services etc. and loose stoploss on less volatile stocks like retail, FMCG, pharma stocks. Moreover, the volatility of different stocks in same industry is different. Volaitlity can also be different for the same stock at different time.
Here too, you have risk of getting your stoploss hit early...
3. Stoploss near support or resistance. This one is also very famous method of stoploss placement. Below support or above resistance areas but that also seem to now work in most of the cases.
'Stoploss hunters' know that majority people are going to place the stoploss below support and above resistance levels. These are very OBVIOUS levels of stoploss orders and in most of the cases they will break support/resistance, take your stoploss and reverse back the market. You can not also place stoploss at obvious levels like below support or below the previous candle low. The chances are that they will be hunted...
How do you place a stoploss which is neither too far away, nor too close?
The answer is volatility based stoploss...
Use volatility as a base to place the stoploss...
In short, when volatility of stock is high, place a bigger stoploss and when volatility is low, place a smaller stoploss...
The tool that is used to measure volatility is Average True Range (ATR). ATR measures the average range of that stock over period of certain days. In short it measures how volatile the stock is.
For example, if ATR of the stock on daily time frame is 20. That means, on an average, the stock moves by 20 points on a particular day.
Lets take 2 stocks both of them trading at 500. One has ATR of 20 and another has ATR of 10. Can we place same stoploss for both? No. Right? You need to place a higher stoploss for 20 ATR stock that 10 ATR stock.
So how to you actually use ATR to place stoploss?
Simply place the stoploss 2 ATR away from entry price.
This way you are giving JUST THE REQUIRED room for stock to move against you before it hits your stoploss.
For example, you buy stock at 500 and ATR on that day is 15, then your stoploss would be 30 points away i.e. at 470. Stoploss of 470 is the APT stoploss. Neither too far, nor too close. Just the OPTIMUM. If it is hit, that means your analysis has failed. Accept and move forward.
The benefit of ATR based stoploss is that it can be universally applied to all the segments let it be stocks, commodities, forex etc. It can be applied on any time frame (i.e. daily, 4 hour, 1 hour, 30 min, 15 min, 5 min etc.). A 5 minute ATR will be less than 15 min ATR right? hence stoploss of 5 minute timeframe would be lesser than 15/30 minute timeframe. It can be applied to stock irrespective of its price level, let it be 80, 160, 520, 1090 or 5078. It does not matter.
Another benefit of this is that it is not most obvious type of stoploss which saves it from 'stoploss hunters'.
I hope you got valuable insights from this article.
Let me know your views in comment box below...