Where To Place Stop Loss

The questions of where and how far should the stop loss be is an issue of major importance for beginners and advanced traders alike.

In this article we will give the basic methodology of placing stop loss when trading chart patterns.

Place Stop Loss in Logical Level
The main idea about Stop Loss is the following: Stop Loss should be in a place that if reached by price, it voids the logic upon the trade is based. If price reaches that level there is no reason of staying in the trade any longer. This is from theoretical point of view.

Practically, stop loss should be exactly below the Support level we trade on, or above Resistance. Each trade you make should happen on Support or Resistance level, and therefore if price breaks these levels - the trade had failed. Stop loss should be exactly near these levels.
Example:

In this signal, the trade occured from a pullback after breakout of support, in a Broadening Megaphone pattern. Trader waits for the Candlestick pattern to evolve, and than he enters. Stop loss is placed right above the candlestick pattern - in this case, Evening Star.

This trade was based on a touch of price in a Resistance level, at the EUR\JPY. A Dark Cloud Cover candlestick formation signaled short entry. Stop loss was placed right above the candlestick pattern.

Note how the stop loss is always dynamic and in relation to price action. Stop Loss is never a constant pip number. Many beginners do the mistake of setting the amount of pips they can afford to lose in Stop Loss. It should be done differently: Stop Loss should be placed in relation to price action, and Trade Size (amount of lots) should be modified depending of the percent of equity one can afford to lose. Trade Size is modified by the trader and his risk parameters, but Stop Loss's location is always defined by the market.

Always calculate your Risk:Reward Ratio
A entire article will be written about this subject, but it should be mentioned here as it is related: Always calculate your risk:reward for any trade you are about to enter. After you have put your Stop Loss, calculate the target for the pattern, and calculate the ratio between the target (reward) and the stop loss (risk). If the risk is not at least 1.5, do not enter the trade.

Do not be tempted to lower your stop loss in order to 'increase' your Risk:Reward ratio. It does not change the real risk for the trade, as stop loss has only one logical place - below support or above resistance.

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