Is it more important to buy right or to sell right? It depends, of course, and that mostly on the used trading system. For trend trading clearly the buy is much more important. The reason is that every stock and any other financial instrument can be bought at any time, but once something is in the account, only that can be sold.
The most astonishing answer to the question about the best or the right stop loss method is therefore, have a sensible buying method in place. Trend trading fits perfectly to working with a stop loss or to general exiting with a trailing stop. So, choosing the right stop may be done simply by just having any stop but a good entry system.
This is an encouraging idea, aligning our trading mood to the optimistic side, which is very important in trading. Nonetheless, we want a better if not the best possible trading system. Finetuning is king for systems. It may be a good bet that there is either one optimal point to stop or that there are a few possible or good stop levels. Unlikely is that the extremum is also the optimum. Having no stop at all or an ultratight one will produce the worst results.
A reasonable stop method is looking for the obvious charting spot or edge to leave the market. Something like a low, for instance, yesterday’s low, or a line of resistance. That makes some sense, as there are also traders who position themselves as buyers just before such a line gets reached and strengthen this border. On the other hand, there are also folks, namely market makers and similar crooks, who try to reach such lines of resistance and break through them, igniting an avalanche and making the quick gain they are after.
Another idea is to deliberately avoid these zones of self-ignition and position the stop order in between them. The more provoking version would be to make up a random stop level. If you randomize your next move you sometimes have an advantage. At least it is often the best you can do, because it makes you unpredictable. That wisdom of fate is from game theory.
A direct consequence of the desired goal, cutting losses short, is to use tight stops. Be careful, this needs a special entry system, otherwise your tight trading system will produce only losses and no single winner. Tight stops need local entry strength. The price must go directly after the trade is put on into the right direction. Such a trading style could be implemented by scanning the markets for a smaller trend within a larger trend, preferably with an automated system.
Perhaps the most sensible thing do to is having a stop that gets triggered when the original reason for buying is not anymore given. For trend trading systems that could mean calculating the size a pullback must have to invalidate the running trend. This is not easy, because there is no clear way for finding the right trend invalidation formula. But on the flip side this gives us the same advantage the random stopper has. For tricky market makers there is no easy way anymore to guess where your stop lies. Trading seems to be a bit like playing Battleships.
Finally, there is the method of setting the stop level in accordance with the current trend and its biggest pullbacks it experienced so far. If this maximal pullback was very small, it may pay off to widen the stop to the trend invalidating one described above. The trend itself should be disturbed severely if you are thrown out. This is of course detrimental to the maxim to minimize losses. But at least for using a trend switching trading system, the magic trading formula that makes money for lazy traders, this sort of relaxed stop level should be optimal.
And as a goody idea: The right stop is the one which would be a trading signal on its own for entering a position in the other direction of the trade. The only question would then be whether this “stop loss technique” shouldn’t be better just called “exit strategy”.
Last but not least, every component of a trading system must fit to all others. The above stop loss considerations are more isolated thought experiments. Any applied stop method must match the rest of the system, most notably the entry strategy.
