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Five Effective Mechanical Trailing Stop Systems

Five Effective Mechanical Trailing Stop Systems
The Ruler System
This is the most primitive and least technical method but can be very effective and like all mechanical methods takes the emotion out of the trade.  All that is required for this system is a ruler and a print out of the chart of the stock being traded.  For this system you would use a 3 month chart and determine the trading range of the stock during this period. Printing the chart and using a ruler you measure the distance between the high and low of the 3 month period.  What ever that distance is will help determine where to place the trailing stop.  An example would be if the distance equals one inch between the high and the low of the 3 month period then as price moves up you would move the stop up equaling one inch below the current stock price as originally measured after your initial purchase.  If the distance of the range is of an inch at initial purchase you would adjust your stop to of an inch below the current price after each days close.  This system is only used when you purchase a stock on a breakout above the range and the original stop is never lowered. This systems works well with less volatile stocks because trading ranges are tight and the risk is lower.  The more volatile the stock the larger the trading range and with that brings the risk of a larger loss if your stop is placed at the bottom of a loose range.  

Price Support System
This is the stop loss method I prefer however it is very difficult to use when buying breakouts of pennants and flag formations.  It is more suitable for the stocks that you buy on breakouts from a solid base or on stocks that pullback to support. The reason for this is normally when buying breakouts of a flag or pennant the stock has already broken out from a solid base.  If you are buying the breakout of the flag you have already missed the initial breakout from the base.  Flags and pennants usually form during the consolidation of a recent breakout well above the initial resistance level which is now considered support.  This breakout of the flag is an excellent secondary buy point but carries much more risk because the only solid support is well below the flag/pennant.  The price support system would be better to use if you caught the initial break out of resistance.  In this case the support is now the old resistance (or breakout point) making for a minimal risk entry with a stop just under the support area and your entry price.  This system also works well for stocks pulling back to support.  After a stock breakouts out from a base it will often come back to test that support.  When it does this is a good entry if you missed the initial breakout because you know that there is solid support at this level and that your stop should be place just below making the entry minimal risk. 

Trading Range System
This system is based on a dollar figure and not percentage.  In this system we would use a 3 month chart and find the trading range much like the ruler method above but instead of a measurement we take the difference between the high and the low of the range as measured in dollars.  For example the 3 month range for XYZ is a high of $25 and a low of $20 difference being $5.  You buy the stock at the breakout above $25 at $25.25 and place your initial trailing stop at $19.90 just below the low point of the 3 month range.  As the stock moves up to $26.00 you move your stop up to $21.00.  You keep moving your stop up trailing the closing price by $5.00.  When the stock reaches $30.00 you move your stop up to $25.00.  $25.00 was your buy point so you can not lose on this trade if it goes south on you.  Remember the trailing stop is always $5.00 in this case since the 3 month range was $5.00.  If the 3 month range is $10.00 then that is always the trailing stop.  As the stock moves up in price you simply move the stop up always trailing the closing price by the dollar figure of the 3 month range. 

Volatile stocks will have wider stop loss ranges.  As the trade improves the sell stop is moved up accordingly.  This type of stop is easy to use and maintain.  However there is a mathematical draw back to the system.  This system is based on an arithmetic price difference and not a percentage so as the trade improves in price the stop tightens.  For example your stock has moved from your original purchase of $25.00 and is now at $50.00.  Using this method your trailing stop is now $45.00.  Your original stop was 20% below your buy price and now since your stock has doubled your stop trails by only 10%.  
Overall Percent System
A simple method for setting stops is to just pick a percentage of each trade that you are willing to risk and stick to it.  Some may chose 5% some may chose 10%.  Right now at STHQ we are trying to stick with 2 to 3% as our maximum loss.  There are drawbacks to this system.  It only works if you have a perfe

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