Understanding the importance of stop losses, whether you are using them just for security or as an integral part of your strategy, there is still a debate among traders about whether fixed or moving stop losses are better – or, a combination of both.
The easy way out is to say, “it depends on your trading style,” but that doesn’t help answer the question of which one is better for you. The reality is, like most things that depend on circumstances, there are pros and cons to both. Some of those advantages and disadvantages are specific to a trading style, and some are generalized.
Some traders can get locked in the idea that because they’ve found the optimal trading mechanic for themselves, this is the optimal trading strategy, and can be a little overly defensive of it, or too strident in advocating for it. Let’s forget that for a moment.
What’s the difference between moving and fixed stop losses?
A fixed stop loss is the easiest to explain: you set your stop loss when you open your trade and keep it there (or, sometimes move it up to break even when the market goes in your favor). The basic idea is that the stop loss does not respond to the market, and you’ll let it run until the trade is closed.
A moving stop loss (also sometimes a “dynamic stop loss”) responds to market conditions; that is, as the market changes, so does the stop loss in response. Now, it’s important to point out that this isn’t just moving the stop loss after the trade has been opened; it implies that the stop loss runs according to some predetermined criteria in line with a trading strategy.
For example, before opening the trade, determining an indicator of a security level, such as the 200 SMA. Thus, the stop loss is set at the 200 SMA and is adjusted according to the indicator movement. The trade will be stopped out when the market crosses the 200 SMA, regardless of what the market is doing.
The temptation that traders always have to overcome when a trade is not going their way and approaching their stop loss is to move the SL away from the market and give their trade some “breathing room.” This defeats the purpose of a stop loss. A stop-loss only works if it has defined criteria that are followed through, irrespective of the market short-term moves.
Sometimes people confuse a moving stop loss with succumbing to the temptation of “correcting” to the change in the market. It does not work that way, and a dynamic stop loss only works for traders with the discipline to keep to the rule or criteria that determines the stop-loss location.
Which one is better?
A fixed stop-loss has the advantage of a “fire and forget” feature; if you aren’t tracking the market during the whole time your trade is open, then having a fixed stop loss helps to keep your trades closing within your strategy. Primarily if you are focusing on setting your stop losses in resistance levels, which tend to remain static on account of the accumulation of orders at a certain point. Additionally, fixed stops don’t require maintenance; you just set them up once, and that’s it.
The disadvantage is that your stops don’t adjust to favorable conditions in the market; which means your cumulative pip loss could end up being higher – although, more predictable.
Moving stops have to be monitored to keep up with the change in the indicator being used to determine the stop level. Thus, they are more suited for day traders, or people who can check up on their trades frequently. As mentioned previously, they also require more discipline, since you have to move the stop every time the indicator changes, making it easy to find an excuse for yourself not to set it according to the rule.
In the end, you have to weigh the pros and cons of each to see which suits your strategy best.