We previously talked about the differences between fixed and moving stop-losses, and if the latter seems like something that could help you with your trading, here are some things you might want to consider.
To reiterate, a moving stop-loss implies setting the stop according to a predetermined indicator, and then following that determination regardless of market moves. It does NOT mean adjusting the stop according to the spot conditions of the market, attempting to keep the trade from stopping out.
Where to start
The primary purpose for using a dynamic stop-loss is to take advantage of improving trends in the market, so it’s best suited for a trader that is present during most of the trading time to keep the stop adjusted accordingly.
The most popular form of moving stop-loss is to set it according to a long-term moving average, such as a 200 SMA. This allows the trader to feel out the long-term trend in the market, and keep the stop around where the market is showing a reverse in trend (and therefore, necessary to reevaluate the trading strategy).
Another form of moving stop-loss is to use Bollinger Bands and use either the edge of the band or the edge plus a fixed number of pips to set where the stop should be. This allows the stop to account for an increase in market volatility while preventing the trade from running away.
Stick to what works
The undergirding consideration, regardless of the indicator chosen, is that it has to be determined before entering the trade and based on money management criteria and applicable across multiple trades. Consistency and replicability typically is the key to long-term trading success, so if you are improvising the stop loss on every trade, it’s not helping to keep you consistently from losing on your trading.
Similar to a fixed stop-loss, if your stop is too shallow – that is, it’s too close to the market – you can be stopped out before your trade has a chance to work. And if it’s too far from the market, you can be taking unnecessary losses. Consequently, when selecting the criteria for your moving loss, you have to take into account the relative market position. (Though one advantage of a moving stop here is that if you see it’s too close to the market, it might be an indication that the trade you are thinking about is not as safe as you thought.)
Fitting with the strategy: security or technique
With money management, an integral part of your plan, the criteria for determining your stop-loss will be an essential aspect of your trading. If you are using stop-losses as a security measure, and enter and leave the market using the indicators, your stop will likely be farther away. A dynamic stop probably will be easier to apply, because you already have the practice and discipline to stop trades, even if they aren’t going the way you want. On the other hand, your trades likely rarely stop out, and only in extreme circumstances, so you won’t get as much benefit from adjusting the stop constantly.
If you are using stops because otherwise, you won’t ever let a trade close in the red, then you shouldn’t be considering a moving stop. Stick to using a fixed stop to protect your account.
If you use stop-losses as part of your strategy, and not just for security in case the market goes widely unexpected, you have a better chance of shaving off some of the pips you would have otherwise lost, by bringing your stop closer in line with the broader market trend. Some trading strategies explicitly rely on using a moving stop in conjunction with a moving take profit – but they tend to be more sophisticated and require following the market regularly.
The final consideration for moving stops is that they are best used in trending markets – if the market is trading sideways, then there is little adjustment to be made according to the trend. So, if your strategy is designed with trending markets in mind, a moving stop might be more useful.