Identifying Stops And Targets by Jeffrey Kaprelian
How do you figure out where to place stops and targets? Try using support and resistance levels together with the average true range.
AS a broker, I am often asked how to figure out where to place stops and targets. There are, of course, many different methods, ranging from not using them at all to using volatility-based figures. One of the most reliable is the use of support and resistance coupled with the average true range (Atr). I will demonstrate this principle using multiple time frames with two unrelated markets to show how truly universal it can be.
First of all, we must define support and resistance. The most basic understanding of support is a level where prices fail to make new lows. The opposite ó the failure to make new highs ó is true for resistance. They can be thought of as floors and ceilings.
SUPPORT AS STOP-LOSS
Figure 1 is a weekly coffee chart. Once the market makes a double low (points 1 and 2), we can use that as a temporary level of support. Observe how the market retraces at points 3, 4, 5, and 6 before it moves away for good. Often, the exact level (56.234) at which the dotted line is drawn is inconsequential relative to any major price points ó in this case, 56.000 ó when setting a stop-loss.
There is no guarantee that stop orders will be filled at the traderís preferred price. Once the stop order has been triggered, it turns into a market order, which is then filled at the best possible price. The fill price may be higher or lower than the price specified by the stop order.