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IG analyst Joshua Mahony introduces three methods for placing your stop loss in 2016
Where to place your stop? Place it too far away, and you could be risking too much on each trade. But place it too close, and your position could get automatically closed due to short-term price fluctuations, incurring a loss on a market that’s actually destined to recover.
Using a stop-loss strategy can help with this problem, by identifying the right places to put stops to ensure that you are making the most from your trades.
The different types of stop
There are three main types of stop that you might want to consider employing in your strategy:
- Basic stops will close out your position when a certain price is reached. They can be affected by slippage if the market moves beyond your specified price before your provider can close your position
- Guaranteed stops work like basic stops, but can’t suffer slippage: they’ll always close your position at the price you specify. If your guaranteed stop is triggered, you’ll have to pay a small premium
- Trailing stops follow the market if it moves in your favour – and when the market turns, your position will close out at your trailing stop’s new level
Three popular methods for placing your stop
The 2% rule
One of the simplest stop-loss strategies, the 2% rule works on the principle that you never risk more than the 2% of your total trading capital on a single position. Traders who follow this principle believe that by only ever risking 2% of your capital on each trade, you can ride out several losing trades while also taking advantage of profitable opportunities.
To apply the 2% rule to your stop-loss strategy, take 2% of your total trading capital and place your stop at the point where your position would lose you that amount – while remembering to take the spread into account.
For instance, you have £10,000 to trade with, and want to spread bet on the FTSE 100 at £10 per point. As 2% of £10,000 is £200, according to the 2% rule you can afford the FTSE 100 to move 20 points against you. So you’d place your stop 20 points from the opening price, plus however much the spread is.