How To Use Chart Patterns To Set Stop Loss Levels

chart patterns

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Chart patterns are great tools for traders. Their visual and predictive nature make them a favorite for stock traders especially. But, using chart patterns to set stop loss levels are an often overlooked benefit, and yet they are one of the easiest ways to manage risk.

Don't Focus Just On The Entry

We all spend hours, days and weeks scanning charts and searching for the best setups. All the hard work to enter a trade and yet little consideration is put into managing the risk side? Maybe it's because we have a nature tendency to think about the money we will make instead of the money we might lose.

Even before you enter a new trade you should have a firm stop loss level in mind. Stops should be placed at levels which indicate that the original trade idea was wrong. And since you know what your risk is ahead of time, having a stop loss level will help control your emotions when and if the trade goes bad.

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Use Chart Pattern Failures

Chart patterns can help us manage risk and still allow us to do this in a rationale way.  Since chart patterns have clear and straight forward breakout points then must also have clear failure points as well. The opposite side of the formation offers us our stop loss level.

For example, take this bullish symmetrical triangle which "should" breakout to the top. Once the breakout occurs and you make a long trade, place the stop loss order underneath the pattern should it turn against you.

An Emotion-Free, Rationale Way To Trade

The beautiful thing about using chart patterns with stop loss levels is that it still protects your upside profit potential in the trade. If the breakout continue to push the stock higher after your entry you keep the money. If not, and the stock reverses and falls back down, then your stop loss order will execute and minimize any losses.

Now you are trading emotion free and more like a professional!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.