Managing Risk: The Art of Setting Stops

If I had to pick one thing that separates successful traders from unsuccessful ones, it probably wouldn’t be finding the perfect stock.

It would be managing risk.

Finding stocks isn’t nearly as difficult as holding them. Every trader eventually discovers that the hardest question isn’t, “What should I buy?” It’s, “When should I sell?”

Unfortunately, there isn’t one perfect answer.

That’s the art of setting stops.

Know When You’re Going to Sell Before You Buy

One of the most important lessons I’ve learned is to know where you’re going to sell before you buy.

Once you’re already in a trade and price begins moving against you, emotions can take over. You may start hoping, second-guessing your plan, or moving your stop lower to avoid taking the loss.

That is why the decision should be made before entering the trade.

Before I buy, I want to know where the setup would no longer make sense. Once I know where I’m wrong, I can measure the distance to that level, determine how much capital I’m willing to risk, and calculate the appropriate position size.

That way, I don’t have to guess what to do once I’m in the position. I already have a plan, and I can let the market decide for me.

This is also why simply following someone else’s stock pick is not enough. Two traders can buy the same stock while having completely different objectives, risk tolerances, timeframes, and exit plans. Without understanding why you’re entering the trade and where you’re going to sell, the stock pick itself has very little value.

You can read more about this in Why a Stock Pick Is Not the Key to Success in Trading.

Every Trader Has to Develop Their Own Process

One of the biggest mistakes traders make is looking for someone else to tell them exactly where to place a stop-loss.

I don’t think trading works that way.

Every trader has a different personality.

Some traders are comfortable sitting through larger pullbacks. Others sleep better knowing they’ll exit quickly if the trade starts moving against them.

Neither approach is right or wrong.

The important part is developing a process you’re comfortable following consistently.

My Charts Use the 13 EMA

People often ask why I use the 13-day exponential moving average on my charts.

The answer is simple.

Over the years, I’ve found that when strong momentum is in place, many stocks will continue to trend above the 13 EMA. When that relationship changes, it’s often the market telling me something has changed.

Does that mean every stock respects the 13 EMA?

Absolutely not.

For traders who prefer to give positions a little more room, the 20- or 34-day moving average can also provide logical areas to define risk, depending on the setup and market environment.

Some traders may find that the 8 EMA, 20-day moving average, 21 EMA, 34 EMA, 50SMA, 200SMA, or another moving average better fits the stocks they trade.

There isn’t one perfect moving average.

Part of becoming a trader is testing different approaches and finding what works for both your personality and the type of stocks you trade.

The important part isn’t choosing the same moving average as someone else. It’s choosing a reference point that fits your plan and deciding how you’ll respond if price breaks that level.

Every Stock Has Its Own Personality

One lesson that’s taken me years to appreciate is that every stock behaves differently.

Some stocks move 1% a day.

Others routinely move 8% to 10%.

It doesn’t make much sense to manage those two stocks exactly the same way.

That’s why understanding volatility is so important.

A more volatile stock often needs more room to fluctuate before the trend is considered broken, while lower-volatility stocks may allow for tighter risk management.

If you’d like to learn more about this concept, I’ve written a separate article explaining how the Average True Range (ATR) can help you better understand a stock’s normal price movement and how volatility can influence stop placement and position sizing.

You can read more about this in How the ATR Is Used in Trading and Stop-Loss Strategies

Every Pattern Has an Expected Outcome

This is one of the biggest lessons I’ve learned.

Every technical pattern comes with an expected outcome.

A bull flag should eventually break higher.

A breakout should continue making higher highs.

A momentum stock should continue respecting its trend.

When those things stop happening, the probabilities begin changing.

That doesn’t automatically mean the trade is over.

But it does mean the market is giving you new information.

Sometimes you don’t need to wait for a stop-loss to be triggered if the original reason for entering the trade no longer exists.

Don’t Be Afraid to Start Small

One of my mentors taught me something I’ll never forget.

He called it a “mental health buy.”

Instead of committing a full position immediately, he would start small.

If momentum continued building and the trade proved him right, he’d gradually add to the position.

Not because he wanted more risk.

Because the market had earned more of his capital.

I still think that’s one of the best lessons I’ve ever learned.

Too many traders do the opposite.

They buy a large position immediately and then hope.

Hope isn’t a strategy.

Let the market prove your thesis first.

Position Size Is Just as Important as the Stop

One of the biggest mistakes traders make is deciding how many shares they want to buy before deciding where they’re wrong.

I believe that process should happen in reverse.

First, determine where your trade no longer makes sense.

Then calculate how much capital you’re willing to risk.

Finally, determine your position size.

That way, before entering the trade, you already know exactly how much you’re willing to lose if the market proves you wrong.

The trade shouldn’t determine your risk.

Your risk should determine the trade.

This is why knowing where you’ll sell before you buy is so important. The stop isn’t something you figure out after the position starts moving against you. It is part of the trade from the beginning.

To learn more about position sizing, read How the ATR Is Used in Trading and Stop-Loss Strategies

The Goal Isn’t to Avoid Losses

This is something every trader eventually learns.

Momentum trading isn’t about being right all the time.

In fact, many momentum traders are wrong more often than they’re right.

The difference is that losing trades remain small while winning trades are allowed to grow.

You might get stopped out several times before finding the stock that trends 50%, 100%, or even more.

Those larger winners can offset many small losses along the way.

That’s why survival is so important.

If you protect your capital, you’ll always have another opportunity.

Don’t Predict. React.

The market doesn’t care what we think.

Today’s bounce could be the beginning of a new uptrend.

It could also be the start of a bear flag.

Nobody knows.

Our job isn’t to predict.

Our job is to react.

Create a plan before entering the trade.

Know where you’re wrong.

Know where you’re going to sell before you buy.

If the market confirms your thesis, stay with it.

If it doesn’t, manage your risk and move on.

Watch the video below:

Final Thoughts

The stock market is one of the toughest riddles in the world.

Success doesn’t come from predicting every move correctly.

It comes from developing a repeatable process that fits your personality, respects the personality of the stocks you trade, and allows you to survive long enough to participate when meaningful opportunities appear.

At SetYourStop, we don’t believe there’s a holy grail.

We believe in building a process.

The art of setting stops isn’t about finding one perfect moving average or one level that works every time. It’s about deciding where you’re wrong, sizing the position around that level, and knowing where you’re going to sell before you buy.

Because once you have a process, the market stops asking you to guess.

It simply asks you to execute your plan.