5 Strategies for Placing Stop Loss Orders - Perpetual Protocol 🥨

Want to learn how to use stop losses effectively? Here are five strategies you can use that will help with stop loss placement and improve risk management when trading crypto.

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1. Support and Resistance Zones

The first strategy for placing stops is to use support and resistance zones. These can be horizontal supports or resistances in the traditional sense or more dynamic measures.

For example, the indicator “Pivot Points Standard” shows horizontal support and resistance levels. You can change the options to see support and resistance levels over different timeframes, as well as different calculation types (traditional, Fibonacci, etc.):

The chart below illustrates how you could place a stop below a weekly support level if you want to go long on ETH-USD:

Dynamic zones of support and resistance are shown by technical indicators, such as the Ichimoku Kinko Hyo. It’s a complicated trading technique best saved for another article, but we’re mentioning it here to demonstrate that support or resistance levels are not always linear or fixed in one place.

Below, we have filtered out all the components except the Ichimoku cloud to illustrate that it usually acts as a zone of support or resistance, especially when the Ichimoku cloud is thicker. Below we can see the price was rejected after trying to pierce the Ichimoku cloud and sent lower. Once the price closed below the Ichimoku cloud, the upper portion was around $1,256, so this would be a sensible area to place a stop when going short.

Another way to determine dynamic areas of support and resistance is to use the Bollinger Bands.

2. Average True Range

An effective stop takes into account the volatility of the market. If you set a stop without considering how much the price is likely to move, then it’s likely to get hit and you may end up closing what could’ve been a successful trade.

To account for volatility in placing a stop loss, you can make use of the Average True Range (ATR). What the ATR tells us is by how much the price of an asset has ranged on average over a certain period of time, which is basically the state of volatility in the market. When the ATR is high, the market is volatile. When the ATR is low, the market isn’t fluctuating as much.

The default setting for the ATR is 14, so if you apply the indicator on the daily chart, it tells you the average price range over the past 14 days. The time period of the ATR can be customized to your liking. You may want to increase the number of trading sessions included in the calculation and choose 30 instead. Under this setting, the ATR will show the average price range over the past 30 hours on the 1-hour chart, the past 30 days on the 1-day chart, and so on.

Below we can see the ATR for the price of ETH is $136.80. Subtract that amount from the previous/current daily low/high to get an idea of where to place the stop-loss. For instance, let’s say you want to long ETH. The ATR is $136.80 and assume that the previous daily low is $1,000. A stop loss can be placed just below $863.20 (= $1,000 - $136.80).

Since, on average, the price has only fluctuated by ~$136 per day in the last two weeks; the stop is placed at an area that gives the long position enough breathing room. You can also use the x2 multiple of the ATR to place safer and wider stops, e.g., instead of $863.20, place the stop below $726.40 (=$1,000 - 2*$136.50).

If there’s a slight dip before your position moves into positive PnL, placing a stop in this way helps you to avoid exiting the trade too early. Another key benefit of using the ATR for stop placement is that your stops become narrower or wider, depending on how volatile the market is.

3. Candlestick Analysis

Candlestick analysis can also be utilized to cut losses at an appropriate level. For example, reversal patterns, such as dojis and hammers, can be useful in placing stop orders. Remember that candlestick patterns are usually more effective on high volume, so make sure you consider this aspect.

Here’s an example: if during a downward trend there’s a long-legged doji or large hammer candlestick pattern with a lot of buy volume, place a stop below the low of such patterns if you like your chances of trading the reversal.

Candlesticks on high timeframes also give clues to important areas of interest. For example, the wicks of different candles on the monthly chart may hint at an important area where there was buying or selling demand.

4. Risk %

Another way to approach stop losses without using any charting techniques is to calculate whatever 1% of your trading capital is equal to and then figuring out the price level at which 1% of your capital is depleted.

For example, let’s say you open a BTC long at $20,000. Your total capital is $10,000, and you entered the long with a position size of 0.50 BTC. One percent of your capital is $100, so your stop loss should be set in a way that automatically cuts the position when the loss is equal to or slightly more than $100. For a 0.50 BTC position, this happens when the price drops by $200. Therefore, you can place a stop around $19,800.

5. Market Structure

If the concept of market structure is new to you, there are two key tenets you should know:

A bullish market structure is one where there are a series of higher highs and higher lows in price.
A bearish market structure is one where there are a series of lower highs and lower lows in price.

If you notice a bullish market structure is bullish, then a stop can be placed below the swing low point. The fractal indicator will mark out important highs and lows on the chart. Notice that in the example below, we have a series of higher lows after a downtrend.

On the other hand, if the market structure is bearish because following an upward move, we have started to see lower highs, then a stop can be placed above the swing high point.

Conclusion

It’s also worth noting that you should stick to your plan and avoid moving stops when a position is at a loss. You should know where you’re going to cut your losses before you enter a trade.

But while it’s not sensible to move a stop further away from your original entry for a losing position, it’s good practice to move a stop when a position turns out to be profitable. This way you can guarantee a profit no matter what the market does!

These strategies are just a guide for you to help you think about placing stop losses (and can also be applied to place limit orders). Remember that you should thoroughly backtest your strategies before being executed in live markets, incorporate many elements and ideally not just rely on one signal or indicator.

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Translations of this article are available in Español, Russian (Русский), and Swahili, thanks to the help of our Perpvangelists!