Common Stop Loss Mistakes and How to Fix Them

While every trader or investor recognizes that they should use stop losses, every trader or investor may not get it right every time. Stop losses are designed to protect against a hefty hit to your account, but unfortunately many traders put those stops in a unnecessarily position where really they don't do a whole lot to help you from the losing positions.

Did you ever find yourself being stopped out only to see that the market turned in the direction you planned for? Or what about riding out a losing trade simply because you did not want to accept the loss? If you have haven’t you must really be on some other level of the trading evolution scale, because let me tell you: It truly sucks!

At the end of the day, stop losses are much more than simply choosing a random \(x\) number of pips. They represent a balance between risk/reward, discipline and market bias. For this post, we will breakdown some of the more common stop loss mistakes along with, most importantly, the end results. 

Mistake 1: Placing stops too tight

Let us say that you just entered a trade on EUR/USD with a stop set only 5 pips away. Sure enough, after entering the trade the price moves just a tad against you, and taps your stop, before shooting up again and hitting the target you were hoping for.

This as you well know is an awful feeling that all traders go through at one time or another. When you set your stop orders too close you are giving the market no breathing room. Each and every market has natural up and downs and when you are too tight your stop loss is often left on the cutting room floor.

• Fix: Remember that you should base your stops on structure, not on sheer guesswork. You can use recent swing highs or lows, or utilize the ATR (average true range), which is an indicator that measures volatility, etc. A well-placed stop-loss should be at a distance, if met, indicates the failure of your trading idea, not simply where the market wobbled.

Mistake 2: Placing Stops Too far away.

On the other end of the spectrum are the traders who move their stops so far away, it almost becomes meaningless. Sure, you will be in the trade for longer, but you have risked a ton of your account to do so.

For example, 100-pip risk on a trade, yet your strategy is typically 30-40-pip targets.  No balance there! One bad trade can wipe out a lot of good trades!

• Fix: Align your stop distance with your lot size. If your trade requires a wider stop, reduce your lot size to keep the overall risk in your comfort zone. Many experienced traders keep it within 1-2% of their account per trade.

Mistake 3: Moving Stops out of Fear

We have all been there, the market is moving closer to your stop-loss, you grab your stop and move it further away. In that moment, you tell yourself the trade should have more "space".  What you are doing is stepping outside your rules and creating a larger loss.

• Fix: Treat your stop-loss as final once the trade is live. The only valid reason to move it, is in your favour when you are locking in profits. Losses are part of the game.Staying true to your plan, even when it hurts—this is what separates disciplined traders from gamblers.

Mistake 4: Market Structure

Another common error is to set stops on a price chart without thinking about the actual price chart.

Some traders simply pluck a random amount of pips or use a fixed method regardless of what is happening on the price chart. The only issue with this is that stops can end up sitting where everyone else's stops are; perfect targets for stop hunts.

• Fix: Think in terms of structure. Where does your trade idea become invalid? If you are going long, perhaps the price is below a strong level of support. If short, perhaps above a recent resistance. You want to place stops where it makes logical sense, technically, not just mathematically.

Mistake 5: Ignoring Volatility Changes

Markets do not behave the same way all of the time. The calm of the Asian session can become the volatility of London morning. A fixed stop loss used in different conditions is like wearing the same coat in winter and summer. One of those times, it will not fit.

• Fix: Be aware of volatility. You can use measures such as the ATR, or even just look at the average size of the candles, during different sessions. Change your stops to suit the volatility of the market.

Short Comparison

Here is a simple table to summarize the mistakes and fixes:

Final Thoughts

Stop losses are not your enemies; they are your safety net. The aim is not to eliminate losses altogether but to learn to take losses so that you can keep trading, and get good at it, so that you can earn money. Everybody makes mistakes at some point as a trader, but traders who are successful are traders who learn quickly and adjust accordingly.

Understanding these common mistakes, and making small changes will not only help to protect your capital, but you will have more confidence when trading. And, if you want to expand on your knowledge in relation to risk management, and trading strategies, check out the Learn section on Wikilix—there's always more to learn.