Candlestick Stop Loss Strategies

Candlestick Stop Loss Strategies

“Progress always involves risk; you cannot steal second base and keep your foot on first.”

Protecting your assets is the main function of putting on stop losses. It is to provide a point where the reason for “buying” becomes null and void. Many trading strategies incorporate them into their trading formulas for closing a trade that has gone sour. Usually this is done by establishing a percentage loss as the parameter. The Candlestick method completely disregards a preset for­mula for stopping out.

There is a major flaw in using a prescribed percentage loss as the stop loss. Your purchase price becomes an important function of where you are to stop out. Some investment advisors recommend three percent as the stop out level. Others suggest eight percent. But where you buy a trade position now becomes the quantitative element of where you should place your stop. A couple of extreme disadvantages become apparent.

A buy recommendation is placed on a stock. You are advised to place a stop at a preset number, for example, three percent below your entry price. The buy is placed on a stock at $50.00. However, by the time you get executed, you have paid $50.80. Buying the stock at $50.00 would have meant your stop out level was $48.50. Your entry at $50.80 now means that the stop loss is to be placed at $49.27. As often mentioned in candlestick analysis, where you bought a stock or sell a stock does not mean a hill a beans to the market. Your arbitrary level of where to come out of a trade has absolutely nothing to do with what the price trend should be doing. What if $48.50 is a level that negates the uptrend move, but $49.27 does not change the trend direction.

Your entry level, although may not have been the ultimate point to get in, does noy have anything to do with what the trend is doing. Prices coming back down through S49.27 may not be a level that affected the uptrend. The “per­centage stop” may have stopped you out while the trend direction was still valid.

“Everything comes to he who hustles while he waits.”

Additionally, the volatility of a particular stock has a great bearing on whether a trend has been affected. A three percent pullback on some stocks might be more than big enough to reverse a trend, while a ten percent move in others stocks is common and isn’t a factor on the trend direction.

The most important factor for establishing a stop loss is very basic. What price point would indicate drat the established trend has been negated? This now becomes a stop loss level that is established based upon the trend being stalled and/or negated. As with all of Candlestick analysis, this becomes a “com­mon - sense” evaluation. If you have put on a long position, based upon a bull­ish buy signal, where would the price have to pull back in order to confirm that tire sellers were still in control?

The simple visual evaluation establishes the proper stop loss point as it pertains to that specific stock position, taking into consideration the volatility of the stock and the signal that created the buy signal. A stop loss on one stock may be relevant at a close level whereas the next stock position requires greater latitude. Candlestick analysis allows the investor to establish a stop loss that would logically indicate when the sellers were still in control, and the buyers have been overcome.