Stop Loss Strategies for Trading in Trending Markets

New traders often focus heavily on finding the "perfect" entry point, believing that it's the key to a successful trade. However, it’s the exit strategy, particularly stop loss management, that ultimately defines the trade’s success or failure. 

Using a Context-Based Exit Strategy

Rather than relying solely on pre-defined targets (like "take profit at 50 pips"), a context-based approach aligns your exit strategy with actual market conditions. By continually assessing the market structure, price action, and trend strength, you can make better-informed decisions on when to exit or adjust your stop losses.

For now, we’ll focus on using the market waves for basing our stop losses on. These should be the waves that match the time horizon of your trade, to keep it simple, that’s usually the timeframe your trade is based on. 

What are Hard and Soft Stop Losses

In our examples we’re going to use both hard and soft stop losses. A "hard" stop loss is an automatic order to exit the trade if the price touches a certain level, while a "soft" stop loss is triggered manually, typically closing the trade if a candle closes beyond a certain price point. 

• Hard Stop-Loss (Red): Set at a point where you determine the trade no longer aligns with your trend analysis. This level should ideally be far enough to account for natural fluctuations but close enough to exit if the market turns against you.
  
  
• Soft Stop-Loss (Orange): Placed at a level that aligns with your strategy but allows manual intervention. If a candle closes beyond this point, the trend may no longer support your position, signalling an exit. This allows the price to fluctuate around that level without automatically triggering a stop loss.

Using Stop Losses 

Here are some stop-loss concepts you can use based on the context. We’ll begin with opportunities where you’re trading with the trend.

1. Set Your Initial Stop Loss Based on Market Structure

Let’s get started by understanding where to place your stop loss when entering a trade. A good stop-loss strategy should align with the market context, such as the market structure and the broader logic of your trading system. 

For example, if you're trading in a bullish trend, you can place your stop loss at the most recent higher low. In this scenario, the trend direction is in your favour, so the goal is to avoid early exiting while the trend is still in your favour.

• Bullish Trend: Place your hard stop loss just below the latest higher low, but give enough room for the price to fluctuate around this area. Place the soft stop loss at the point where the low is broken. Only trigger the soft stop loss if the price closes below the previous low.

‍

• Bearish Trend:  Place your hard stop loss just above the latest lower high, but give enough room for the price to fluctuate around this area. Place the soft stop loss at the point where the high is broken. Only trigger the soft stop loss if the price closes above the previous high.

This approach provides a good starting point by making sure the stop loss is based on something logical, the structure that supports your trade. 

If your stop loss is hit, that would be a signal the trend may be about to change as a new high or low was just created. The context has changed at that point, and your trade is unlikely to still be valid.

2. Adjusting Your Stop Loss

The markets are constantly moving, so we need to adjust our stop losses as the conditions change. However, adjusting too soon may cut off profitable trades, while holding back may leave more risk exposed. Here are strategies to guide your adjustments:

• After Higher Highs or Lower Lows: If the price makes a higher high (in an uptrend) or a lower low (in a downtrend), adjust your stop loss to the last low or high. This way, if the trend reverses, your stop loss will trigger before all your profit disappears.

‍

• In a Strong Trend: When a trade gains significant momentum in line with the trend, you might consider moving the stop loss to breakeven to protect your capital in case the market reverses against you.

3. Identify Trend Weaknesses to Exit Early

As the market changes, so should your stop-loss approach. If the market shows trend weakness including the appearance of lower lows in a bullish trend or higher highs in a bearish trend, we may need to adjust the stop loss. When such structural shifts occur, they suggest uncertainty or potential trend reversals.

• Trend Weakness: When a new low in a bullish market goes below a previous low (or a new high in a bearish trend exceeds a previous high), tighten your stop loss or exit.

‍

4. Adjusting Your Stop-Loss When Trading Against the Trend

Entering a counter-trend trade typically means anticipating a reversal, which can be more risky.

• Alternative Levels: Rather than structure, you may want to use your entry criteria for the stop-loss levels. With the Duomo method, this would be our significant levels.

‍

• Setting at Break-Even: As the price moves in your favour, moving your stop loss to break-even early protects you if the trend resumes.

Why Does This Matter?

As you can see, each of our stop losses are based on something logical. By setting initial stops based on market structure, recognising signals for trend weakening, using hard and soft stop losses, and adjusting strategies between trades with and against trends, you are making decisions based on the context of the market.

Using a context-based exit approach, rather than relying on arbitrary targets, keeps your trades aligned with the market. There are many more approaches you can use for stop loss placement, but this is a good place to start.

You may want to check out our article on Stop Loss Strategies in Ranging Markets next.