In this section, we’ll talk about the common mistakes traders make when using stops. Sure, it’s one way to practice proper risk management but when used incorrectly, it could lead to more losses than wins. And you don’t want that, do ya?
1. Placing stops too dang tight.
The first common mistake is placing stops tighter than those leather pants that Big Pippin used to wear back in the retro days.They’re so tight that there ain’t no room to breathe!
In placing ultra-tight stops on trades, there won’t be enough “breathing room” for the price to fluctuate before ultimately heading your way.
Always remember to account for the pair’s volatility and the fact that it could dilly-dally around your entry point for a bit before continuing in a particular direction.
For instance, let’s say you went long GBP/JPY at 145.00 with a stop at 144.90. Even if you are right in predicting that the price would bounce from that area, it’s a possibility that the price will still dip 10-15 pips lower than your entry price before popping higher, probably until 147.00.
But guess what?
You weren’t able to rake in a 200-pip profit because you got stopped out in a jiffy. So don’t forget: Give your trade enough breathing room and take volatility into account!
2. Using position size like “X number of pips” as a basis for stops.
We’ve mentioned this earlier in the lesson already: Using position size like “X number of pips” or “$X amount” instead of technical analysis to determine stops is a BAD idea. We learned that from Newbie Ned, remember?
As we discussed, using position sizing to calculate how far your stop should be has nothing to do with how the market is behaving. Since we’re trading the market, it’d make much more sense to set stops depending on how the market moves.
After all, you picked your entry point and targets based on technical analysis so you should do the same for your stop.
We’re not saying that you should forget about position size completely. What we’re recommending is that you should decide where to place your stops first BEFORE calculating your position size.
3. Placing stops too far or too wide.
Some traders make the mistake of setting stops way too far, crossing their fingers that price action will head their way sooner or later. Well, what’s the point of setting stops then?
What’s the point of holding on to a trade that keeps losing and losing when you can use that money to go for a more profitable one?
Setting stops too far increase the amount of pips your trade needs to move in your favor to make the trade worth the risk.
The general rule of thumb is to place stops closer to entry than profit targets.
Of course you’d want to go for less risk and bigger reward, right? With a good reward-to-risk ratio, say 2:1, you’d be more likely to end up with profits if you’re right on the money with your trades at least 50% of the time.
4. Placing stops exactly on support/resistance levels.
Setting stops too tight? Bad. Setting stops too far? Bad. Where exactly is a good stop placed then? Well, not exactly on support or resistance levels, we can tell you that. How come?
Didn’t we just say that technical analysis is the way to go when determining stops? Sure, it’s helpful to note nearby support and resistance levels when deciding where to place stops.
If you’re going long, you can just look for a nearby support level below your entry and set your stop in that area. If you’re going short, you can find out where the next resistance level above your entry is and put your stop around there.
But why isn’t it a good idea to put it right smack on the support or resistance level? The reason is that the price could still have a chance to turn and head your direction upon reaching that level.
If you place your stop a few pips beyond that area then you’d be more or less sure that the support or resistance is already broken and you can then acknowledge that your trade idea was wrong.