Stop, or cut loss point, is an essential component is trading. It serve as a trigger to tell you that the market does not agree with your analysis.
Stop loss should be formulated BEFORE one enter into position. This is because without a position, one can see the whole picture clearer without being affected by emotion. Considering stop loss at this point of time also make one think about the risk and reward ratio, thus the attractiveness of the trade one is about to take.
There are many ways to place a stop. You can use a method that is related to your entry/exit, or you one that is not. You can use one stop placement method for all market conditions, you can also use different stop placement method in different situation. You can also use a combinations and select the widest or tightest stop you deem fit.
The simplest, I think is to use a fixed x ticks or x% below entry price as a stop (when you are long). When price moves x ticks or x % below the entry price, cut. This method is quite effective in giving *protection* to your capital, though I personally do not quite like this as the exact price point may not always seems logical on charts.
Another way is using of a moving average (MA). However, using this one has to balance volatility that give raise to false signals and responsiveness so that stop can be executed in time to protect profit or capital. The key here is to select the *appropriate* MA that suit your need. This key is not easy to find, mind you.
Volatility can be formulated and to give a stop price. The basic idea is since price had been fluctuation between certain range lately, any fluctuation beyond that range indicate a change in price behaviour. So it is better to get out if this change of behaviour is against your favour. Volatility based stop can come in the form of average true range (ATR), standard deviation / error etc. The famous turtle trading rules uses a volatility based stop.
Trend lines can also be used as stop, be it horizontal or inclining. This means that once a trend line is violated, the trends has changed and it is best to get out and sideline first. To prevent stop being *picked*, stop should be placed 1 or 2 ticks below trend line or support. Consideration must also be given to the liquidity of the counters: price movement of illiquid counters can easily be manipulated and push across trend lines to shake out the unawared.
Another one that is related to the above is a chart based stop. A price movement that goes below previous low (in the case you are long), or voiding certain patterns or formations can also signal the analysis is wrong. Eg: EW wave 4 should not retrace into wave 1, once that happen, the count for wave 4 is wrong and logically the stop/exit must be implemented accordingly.
For those who are using software, there is this Parabolic SAR and Countback line (by Daryl Guppy's, see
http://www.guppytraders.com). Both are a good trailing stop indicators and worth your time exploring.
Stop need not be static. I recommend stop only move in one direction: UP (when you are long). By this I mean to raise the stop to the next support level, or [high-x ticks], or any other logical level. This trailing stop is good for protecting your gain.
Carefully select stop should be easy to execute. Do NOT try place the stop, together with position size that make you hesitate when come to execution (see separate threads about position sizing for details about "flush point"). Try to get rid of every possible obstacles to stop execution before entering into position; so that it can be done decisively when it has to be done.
And always remember: the first cut is always the best cut.
But what if the price move up again after I cut? That I have only a partial answer; there is no perfect solution (for me at least). One way to separate your position into 2 portions that have a difference cut loss point. Trim your position partially when the tightest stop hit and cut the rest when the situation is obviously wrong when the wider stop is hit. Alternatively, take the first shake out as part of trading and move on, analyse re-entry as a fresh new trading opportunity (no revenge here please).
Even though we explore many options here, please do not forget the big picture: stop placement is just one of the component of trading.
Happy and profitable trading to all.