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Traders will obsess over their trade entry but won’t give a second thought to where they will place their stop loss.
If we can agree that managing your trading risk is job #1 for a trader, then we can agree that it’s vital to know when to get out of a trade gone bad.
One huge issue is that many traders will place their stop in a location where the trade is still valid because it means they can have a larger position size.
You probably recognize this type of protective stop loss:
stop loss order
Protective stop loss directly under support structure
The textbooks will tell you to place your stop loss right under support because if support breaks, your trade is no longer valid.
It will also allow you to use a higher position size which to most traders is something they support because they are under capitalized.
The problem is that this protective stop ignores basic fundamentals of how markets operate.
Breaks Don’t Always Invalidate Your Trade
In the example above, price came down to support, formed a trading range above support and then took off to the upside. It’s a perfect example of a continuation play but rarely do we see such clean levels in the real market.
The market is not an orderly arena and there is a lot of “noise” in the market that you must account for. When looking at obvious levels, you should be expecting that attention will be paid to it by many traders especially those who can really move the market.
Novice traders (and more experienced as well) will use these textbook locations and a cluster of stops will be sitting ripe for the pickings.
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