In the previous article, we talked about how to set a stop loss by using a percentage-based amount of your account balance. A second way to set a stop loss that we will be discussing is a chart-based approach — a support and resistance based stop loss. This method involves using support and resistance levels to find a good stop-loss level for your trade.
Stop-loss orders can be an essential tool for any trader, as they help to protect your money from big, unexpected losses. An important part of trading is understanding the concept of a support or resistance level and how to use it to set your stop loss. A support level is an area where sellers seem unwilling to push prices lower, while a resistance level is exactly the opposite; an area where buyers are unwilling to push the price higher. By understanding these levels, you can help identify key points where you may want to place your stop-loss order, providing more security and assurance that you will not experience undue losses on a trade.
Place your stop loss just below the support level if you’re buying, or just above the resistance level if you’re selling.
Using a support and resistance based stop loss at the right points is critical to any successful trading strategy. With this method, a stop loss should be placed just below the support level if you’re buying, or just above the resistance level if you’re selling to protect your position against volatility and/or an invalid trade idea. Setting a stop loss at these key areas allows you to get out of a bad trade without significant losses, giving you an important safety net in an unpredictable market.
If the price action breaks through this level, it’s likely to continue moving in that direction, so you don’t want to be in the way!
With all the uncertainty in the markets, it’s important to keep an eye on the price action and be aware of current levels. Knowing just how far prices could shoot up or drop down can help you make wise decisions for your trades. For example, if the price action breaks through a certain level, then it’s likely to continue moving in that direction. Therefore, you don’t want to be in its way, as it will be more difficult to come out ahead. So, by setting your stops just beyond support or resistance levels, you are safeguarding against a bad move against you.
A Support and Resistance Based Stop Loss Example
As we mentioned, support and resistance levels are where price action continues to test the same level or zone, struggling to break beyond those levels. By setting your stop loss just beyond these support and resistance zones, you are playing within the areas that the market is dictating.
Think about it. If there is a break of a support or resistance level, many traders will continue to play the break and push price action against you. By having a stop loss just beyond that level, you ensure that a market move against you does not wipe you out.
Let’s take a look at a quick example…
You look at the EURUSD hourly chart and notice that price action has broken through the trendline and so you decide to put on a buy trade.
But where could you place your stop? What are the market conditions and past price action telling you? You also notice that there is a strong support zone and so you place your stop right below that zone. If the price moves into the support area, you can be sure the trendline had no support and the sellers took over — and your trade was invalidated.
But, you let the trade run, and — voila — you bank a nice healthy profit.
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