Technical Stop Loss

For those people using technical analysis as a primary method of entering trades, they should be able to theoretically determine at what point on the chart their opinion, regarding the likely direction of the share price, will have changed. This would be an ideal place to position an exit.

There are theoritically an infinite number of potential exits points based on this however some of the more common methods include breaking back down below a moving average, moving back down below the previous trough, breaking down and staying below the prevailing support level and the list goes on. The best way to explain this approach is not through mathematics, rather practical examples.

Consider this chart:

Notice the price action reaching the dotted line at 0.85, which is representing a clear level of resistance. It is wise to wait for this level to be broken before initiating a trade.

Once the price breaks through this resistance level, a trade is entered. To employ a technical stop in this situation, you may consider the resistance level that was the critical factor in deciding to enter.

It is commonly known that when a resistance level is broken, it often becomes a support level. Based on this, we could place the initial stop loss just below the previous level of resistance (0.85) at around 0.83.

If this stock trades back down to 0.83, then the technical reason for the trade entry in the first place now no longer exists. Any support that may have been expected at the 0.85 level has now been broken, so therefore it would be appropriate to exit the trade.

That is a simple example of a technical exit using the concept of support and resistance.

Another example could be using a moving average.

Consider the same chart with a moving average plotted.

The moving average leading up to the same time as the entry in the previous example is clearly showing an up trend. You decide to entry at the same based on the break above the resistance level.

The moving average is ideally positioned to be used as a technical stop. As the price moves higher and the moving average trails behind, it continues to be well positioned to be used a technical stop, in that should the price trade and close below the moving average, that would be the signal to close the trade.

One thing should be made clear about using technical stops. Arguably it is the most effective way of determining suitable initial stop loss points however you need to be careful.

It is however, the one method that can easily allow you to be subjective – percentage and volatility stops are very precise, ie. you use the calculator and work out where your stops are going to be. It is fair to say that for inexperienced traders, there are the best to use.

With technical stops, you are using your own judgement to determine the best position for your stop loss. A person requires some experience and a certain level of intuition before they can be confident with their use of technical stops.

“Learn to take losses. The most important thing in making money is not letting your losses get out of hand.”
Marty Schwartz