Theoretical basis of stop loss
The risk/return ratio is the ratio of the potential loss to the expected return of a stock transaction. For example, if we plan to execute a transaction with a potential loss of 100 points and a potential profit target of 300 points, then the risk return ratio of this transaction is 1:3.
Risk/return ratio=Entry price - Stop loss price/Target price - Entry price
Success rate "refers to the probability of a successful transaction. For example, if there are 7 profitable trades out of 10, the success rate is 70%.
Assuming our 'risk/return ratio' is 100 points of potential loss/300 points of potential profit, with a success rate of 70%, this means that out of 10 trades we made a total of 7 profits, each earning 300 points; There have been 3 losses, each losing 100 points. After 10 transactions, the overall profit will be 300x7-100x3=1800 points.
Assuming our risk return ratio is 300 potential losses/100 potential profits, with a success rate of 90%, losing 300 points each time and earning 100 points each time, then in 10 trades, the overall profit will be 100x9-300x1=600 points.
A trade with a lower risk/return ratio and higher success rate is considered a good trade. For a detailed description of the risk/return ratio, please refer to the "High Winning Trading" chapter in the beginner's guide to Stock Connect.
Determine stop loss level
1、 Technical analysis stop loss method
Letting the market tell the stop loss position is the correct method. How stocks should develop, they will develop accordingly.
There are many methods to set stop loss through technical analysis. For example, the stop loss position can refer to the golden ratio line, dense trading area, important candlestick line, pattern, etc. They are the mainstream pressure support levels in technical analysis.
When doing more, set the stop loss below the support level. When shorting, set the stop loss above the pressure.
1. Golden Ratio Stop Loss Method
Using the golden ratio to determine support and resistance levels, in order to identify entry points and determine appropriate stop loss and target levels.
The golden ratio is a leading tool that can be used to "predict" these support and resistance levels in advance. For a detailed description of the golden ratio, please refer to the "Golden Ratio" chapter for beginners.
2. Stop loss method in densely traded areas
The dense trading area is an important basis for stop loss.
The bottom of the dense trading area is the bottom limit of support. If you buy here and set a stop loss under support, there will be a wide upward profit margin. Some traders will buy during a pullback after an upward breakthrough and set a stop loss within the intensive trading zone. An effective upward breakthrough usually does not bring it back into the trading range, just like gunpowder should not return to the launch pad.
However, false breakthroughs often occur in densely traded areas, making traders susceptible to deception. If necessary, psychological stop loss can be used for this.
In the intensive trading area, when you perceive that the price is about to break through and show an upward trend, you must decide to enter immediately or wait for a pullback.
If you take immediate action, you can immediately enter the trend, but stop loss orders may be set far away, which increases risk.
If you wait for a pullback, although the risk is relatively low, you must face four groups of competitors: long positions that are overweight, short positions that are covering, new long positions that are entering the market, and traders who sell too early and hope to re-enter the market. The 'waiting area' for Pullback will be very crowded!
3. K-line stop loss method
K-line stop loss method. Including the appearance of typical K-lines such as the top big bearish line, meteor line, and bearish eclipse.
For a detailed description of K-lines, please refer to the "K-Line" chapter for beginners.
4. Form stop loss method
Price breaks the neck line position of head and shoulder tops, M-heads, curved tops, and other head shapes.
Let's take the example of head, shoulder, and bottom to see how to use form stop loss.
In an effective downward trend, it remains in a downtrend until the left shoulder. The rebound trend of the head breaking through the downtrend line upwards is a signal of the end of the downtrend. After the formation of the right shoulder, the price broke through the neck line and released bullish signals such as the long yang line, which confirmed a new upward trend. After the neck line broke through, the price never pulled back to the vicinity of the neck line. The initial target position can be above the neck line, with a distance equal to the distance from the neck to the head. Generally speaking, after the head, shoulders, and bottom are arranged, the price increase will exceed the target price.
Firstly, the buying point is set at the retracement point after breaking the neck line, and the stop loss is set slightly below the "right shoulder".
Secondly, the buying point can also be set at the bottom of the right shoulder, and the stop loss point can be set below the head.
Thirdly, the buying point can also be set after breaking through the neck line, as there is no pullback after the breakthrough, but a direct upward trend. Because it is a price chasing entry, a wider stop loss is used. But as long as the risk/return ratio multiplied by the success rate is appropriate, one can enter the market.
In terms of trading tactics, the bottom of the head and shoulders is very similar to the top of the head and shoulders. In the usual bottom form, the trading risk borne by funds is relatively low, and price fluctuations are relatively mild, so tight stop loss can be adopted. In the top form, price fluctuations are often severe, and loose stop losses can be used.
For a detailed description of the form, please refer to the "Form" chapter for beginners.
