How to Set Your Stop Loss Orders via Technical Analysis

How to Set Your Stop Loss?

The stop loss order is one of the key components to a healthy risk management.

Whether you are trading Forex, Stocks, Commodities, ETF’s, Indices, CFD’s or Cryptocurrencies, if a stop loss order is not implemented to your open trades (preferably upon execution) you will be reluctantly forced into tiring psychological battles with yourself that could cost you a substantial amount of capital with no guarantees of claiming victory over the market.

It is surprising how many traders are randomly placing their stops in the market, often selecting a fixed amount pips/points/cents for every position.

If you are new to forex trading it is essential to learn how to calculate the value of the pips. If you do not know the value of each pip when setting a stop loss you may incur greater losses than initially thought.

The refusal to understand a stop loss must be determined by technical analysis, even for fundamental trading in our views, is turning your invested capital into a three-course meal for the notorious bears and bulls in global markets, deserting over the extensive usage of the offered leverage.

Stops Contain Losses in Trading

A stop loss order is set to protect your investment from being brutally scarred by the market. It is your runaway car in your attempt to flee the market when the tables turn against your technical or fundamental outlook.

There will be times you must raise a white flag, acknowledge your loss and carry on in your everlasting battle with the bears and bulls, crafting your next trading strategy while you are out of the market.

We would like to present you with multiple stop loss trading strategies that clarify where to place your stops to ensure you are aware of the required analysis for this delicate order.

Our goal is to provide each trader will real market education to prevent steep losses in trading the global markets.

Stop Loss Strategies: Support/Resistance

Support and resistance levels are used in numerous trading strategies to evaluate  the targets technical analysis as well as stop loss setting. We took EURJPY as an example:

EURJPY 30min Chart

Please click on the chart to enlarge:

EURJPY Stop Loss Strategy Example

EURJPY 30min Chart, 2 September 2014

The support level is seen at 137.51, resistance at 137.50. The support and resistance levels are determined by at least two points the market was unable to close below (support) or alternatively close above (resistance).

We strongly recommend to refrain from various indicators that automatically  draw these levels and adopt a Do It Yourself (DIY) approach as it will only serve you in the long-term.

Once the support and resistance levels are established, the trader may place his protective stop loss order above the resistance if he or she considers to short the market or execute a long trade with a protective stop below the support level.

The technical reasoning is that if the market is unable to close above/below a certain price region on multiple occasions, the third time will not differ.

In our example, EURJPY is close to its support level, which means a long trade may be taken with a stop loss order below 137.51.  In another scenario however, if the price closes below the support or above the resistance, breakout strategies will come into play.

To simplify, when the price takes out the resistance level,  we would expect the gains to continue and vice versa. If the price firmly breaks the support level we would expect the weakness to resume.

There is an important rule in such scenarios. If the resistance is breached, it automatically turns into a support level.

If  I then wish to execute a long position, the protective stop must be layered below the breached resistance, which is now acting as a support level. The same applies when a support level is breached.

#Upon the breakout, I may enter a short trade into the market, layering my protective stop loss order above the breached support, which is now acting as a resistance level. Of course, support and resistance levels can be enhanced by exercising Moving Averages.

Stop Loss Strategies: Moving Averages

A moving average can also be used on its own to determine stop loss orders positioning. To simplify, if a 21 moving average (MA) is used, the indicator calculates the closing price of 21 sessions (candlesticks) and divides the total amount by the number of sessions, which in this case is 21.

While moving averages are often used in trading strategies they can be used for determining the stop loss position if a short or long trades. In the chart below we have added the 21MA to EURJPY 30min chart:

EURJPY 30min Chart with 21MA

Please click on the chart to enlarge:

EURJPY with 21MA

EURJPY 30min Chart, 2 September 2014

As you may note, the 21MA is within a close proximity to the support level. If the price will close above the 21MA we have a stronger indication that EURJPY may reverse higher within a 30min time frame.

As the support level is now a firmer support due do the 21MA, we can comfortably place our stop below 137.51 or even below the 21MA for tighter stop loss. It is essential to highlight the MA can be used as a resistance level as well as support.

In other scenarios, the support/resistance levels and the MA may have quite a distance from each other. A stop loss can be just by the using the MA as long as it acted as a support/resistance in previous sessions as shown in the chart above. The MA’s periods that are commonly used are 15,21,55,100 and 200.

Stop Loss Strategies: Fibonacci

Fibonacci is a fascinating tool which is not limited exclusively for trading. The human body, ears and cells for example are all based on Fibonacci.

In trading, Fibonacci can be used for setting targets as well as predetermining the stop loss for your trades. The concept of Fibonacci retracements is to determine when the bearish or bullish trend is due to expire.

Let’s take a scenario where EURJPY gained 200 pips in three hours. A technical retracement is bound to take place at some point.

When it begins, Fibonacci is drawn from the lowest price to highest price to produce multiple retracement levels that are based on percentage points. We will focus on 23.6%,  38.2%, 50.0% and 61.8%.

If EURJPY bearish retracement reaches 23.6% but the price is unable to close below, we have our Fibonacci support level where a protective stop can be placed below in order to establish a long trade.

If the price breaks the 23.6% level we would expect the weakness to continue towards the 38.2% retracement level.

If the price reaches 38.2% but doesn’t close below, we have a Fibonacci support and a stop loss can be placed below in order to execute a long trade. Fibonacci is not confined for just bearish retracements.

If EURJPY drops 200 points and corrective gains are taking place, Fibonacci is drawn from the highest price to the lowest price to produce multiple resistance levels.

Breakout strategies can also be applied by using Fibonacci. For general reference, 50.0% is considered as a healthy retracement while 61.8% is classified as a strong level.

EURJPY 30min Chart with Fibonacci
EURJPY 30min chart, 02/09/14

EURJPY with Fibonacci, 2 September 2014

The nearest Fibonacci level is seen at the 23.6% (137.46). It is not inline with the support level we have shown earlier (137.51). Conservative traders may choose to place the protective stop below 137.46 as a precaution. If the support level is breached they would expect Fibonacci to contain the weakness.

Another approach to Fibonacci retracement levels is to apply it on multiple time frames. In out example we only applied it to EURJPY 30min chart.

If Fibonacci is drawn on multiple time frames, 15min, 30min, 60min, 4 hours, daily and weekly, traders would look for a price level where a Fibonacci support/resistance that is in the exact same region in two different time frames.

To clarify, if 137.51 is a Fibonacci support on the 30min and the 4hr chart, the support level is expected to be relatively firm.

In the forex signals we provide we calculate the location of the stop based on technical analysis. November 2021 forex signals may be a great example how it is done in real time.

Stop Loss Strategies: ATR

The Average True Range (ATR) is a technical indicator that is commonly used for placing stops in the global markets, particularly in the Forex market.

The indicator was originally developed by J. Wells Wilder Junior for commodities. The ATR indicator does not provide the market trend but measures the market volatility. In EURJPY 30 min chart the ATR notified us the volatility is 10 pips.

EURJPY 30min Chart with the ATR

Please click on the chart to enlarge:

EURJPY sopt loss strategy, 02/09/14

EURJPY 30min chart with ATR, 2 September 2014

In order to set the stop loss (either long or short), traders often use 150% or 200% of the ATR. To simplify, as the ATR is 10 pips, 150% would be a 15 pips stop. With 200%, we simply multiply the ATR by two, which will be interpreted to a 20 pips stop.

The ATR does not require support/resistance levels, moving averages or Fibonacci but it is wisely combined with the above to ensure a strategic stop is placed for your positions. Since we used a 30 min chart the ATR is relatively small and will increase with the selected time frame. The ATR on EURJPY daily chart at the time of this writing is 58 pips.

We have covered multiple trading strategies that can be combined together in order to establish the stop loss location for your trades. We discussed earlier that EURJPY is nearing its support level, concreted by the 21MA.

This is the current EURJPY 30min chart, please click on the chart to enlarge:

EURJPY 30min chart, 02/09/14

EURJPY current 30min Chart, 2 September 2014

You may note the price rebounded off the 21MA, taking out the intraday resistance at the time of this writing. We are using multiple techniques for establishing our stop loss which we do not display on the charts to ensure it remains clean for the experienced and inexperienced eye.

Another popular method of layering stop loss orders in the market is known as double daily close or managing the risk via the margin. We described these stop loss trading strategies in a separate page that you are welcome to review.

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There are many strategies that do not require a stop loss as hedging is used. If you are relatively new to the market or lack the experience of hedging we suggest not to enter these dark waters.

In rare occasions we exercise hedging strategies and we have been very successful without them. We hope the stop loss trading strategies will serve you in trading the market.

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Last Updated on September 19, 2021