How to use stop losses effectively [3]

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Percentage approach to stop losses: this is really just a variation of the arbitrary nominal cash approach described above. The only difference here is that instead of a nominal cash amount, a predetermined arbitrary maximum percentage loss amount is used to derive the maximum spread betting point loss. So, for a trader with an account size of £10000 who has decided not to lose any more than 2% on a single trade, the maximum acceptable loss on any single trade is £200. from here, the rest of the steps to determine the stoploss level for the particular share being traded is just as described above.

Technically-driven approach: A key short coming of the nominal cash approach described above is that it is rather arbitrary as the cash amount is simply based on the trader’s view of her maximum acceptable loss without any reference to actual price action or market evidence.

An alternative approach that avoids this weakness is the technically-driven approach to determining optimal stop loss levels.

Under this approach, the spread bet trader would first identify key support and resistance points on the price chart. This enables the trader to determine areas that may act as price turning points. Once that has been done, as the trade is placed, a stop loss order is placed just above the resistance level (if the trade is a short sell) or just below the chart support level (if the trade is a buy bet). A key advantage of this approach is that the spread bet trader is able to trade more objectively and less emotionally.

Note that although using the technically-derived stoploss approach may mean that you place the stop further away from the price level than the arbitrary nominal cash approach may suggest, it does not necessarily mean that you have to increase the maximum amount of cash that you are willing to lose. Since the maximum cash loss is a function of the bet size and the stop level, you simply reduce the spread bet size, thus leaving the maximum potential loss unchanged.

In this example provided above, say you identify the important support level as £3.00 (as opposed to the £4 that a spread trader using a nominal cash approach would have used), then to maintain the maximum acceptable loss as £200, you simply divide the maximum acceptable loss by the number maximum points loss. Maximum point loss here is the difference between the entry level of £5.00 and the identified stop level of £3.00 = 200 points. Therefore, in this example, the maximum stake = £1.

Note that in the two examples presented above, it is assumed that the spread bet trader uses a guaranteed stop loss. This is the only way to ensure that you only actually lose the predetermined amount of money that you decided.

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