The profit protection stop seeks to lock in a piece of a winning trade while allowing the position to unfold as visualized in the pre-trade analysis. It keeps its distance when well-placed, letting the security to wiggle and wobble through high noise levels common in intraday markets, but ready to mitigate damage if the trend suddenly changes.

Trading is an odds game in which anything can happen at any time. Stops address this uncertainty, providing a safe exit when conditions change or the position fails due to poor planning or execution. Stops come in many varieties, including stop losses at levels where the technical setup gets broken, free stops placed at the point of entry, and profit protection stops when the technical setup works as intended.

Three variations of the profit protection stop manage positions at all phases of development. These are categorized by their relationship with the underlying security: stationary, trailing, and accelerating. Each has a time-specific advantage and none works well in all market conditions. Generally speaking, the first works early in the life of the trade, the second as the profit develops, and the third when the trade nears the reward target, increasing the odds for a countertrend to take control. (For more, see Must-Know Simple & Effective Exit Trading Strategies.)

Stationary Stops

The stationary stop marks a pre-chosen price level where a small profit will be taken if the security turns against the intended direction. This type of stop is intended to protect capital in the first hours or days after a new trade, ensuring a winning position. The first stationary stop is often placed just above the break-even level to allow a free trade that lowers anxiety levels.

This stop gets moved at regular intervals as long as price advances in the intended direction. It’s like a game of hopscotch in which the trader jumps from one safe haven to another, locking in more capital with each jump. You choose each level by looking for small bases or price clusters on the chart in the time frame below the one used to find the opportunity. For example, if you found the trade on the daily chart, place the stationary stop behind a base on the 60-minute chart.

QQQ Stationary Stop Placement

The trader buys the Powershares QQQ Trust (QQQ) trendline breakout at 104 and watches it for two sessions, waiting for the position to move into a profit. It gaps higher on the third day, allowing a stationary stop just below the gap fill level at 105. This protects just a small profit but it’s now a free trade that builds confidence, allowing more objective management as price action unfolds.

Trailing Stops

The trailing stop identifies a flat price or percentage distance from the security, moving in lockstep in the intended direction. The stop stands firm during reversals and whipsaws, getting hit if the predetermined distance is crossed. These stops work best in the middle of a profitable trade, with a good distance between the entry price and reward target. Avoid the tendency to place the stop too close to the security during this phase, to avoid getting hit during routine counter swings.

Keep the trailing stop loose when the position is less than 50% of the distance between the entry price and intended exit, tightening up as it crosses that threshold and heads toward the 75% level. The most effective trailing stops adjust to the security’s characteristics, tighter on low beta issues and looser with momentum trades and other high beta issues. They also respond to current conditions, looser in high volatility markets and tighter in low volatility markets.

QQQ Trailing Stop Placement

The QQQ position accelerates to the upside in mid-February, supporting a series of trailing stops while the trader eyes significant resistance above 109. The 60-minute chart provides the details required to identify basing patterns, price clusters and gaps that can be used to place stops out of the way of current price action, where they’ll only get hit if there’s a significant reversal. 

Accelerating Stops

The accelerating stop identifies a price or percentage distance from the security that’s adjusted closer and closer in real time as the advancing trade approaches a significant reward target. Use this stop when the position has moved 75% or more of the distance between the entry and intended exit price, identified by technical barriers that include moving averages, prior highs or lows, Fibonacci retracements, and gaps. (For more, see Strategies To Trade The Reward-Risk Equation.)

This is an aggressive lock-in strategy that offers a quick exit during a counter wave when the price is trading into the reward target, while allowing for momentum to take control, exceed the target and provide a windfall profit. For a typical $100 security, the accelerating stop can start at a dollar or two behind price at the 75% level, shifting to 25 to 50-cents as it approaches the reward target.

QQQ Accelerated Stop Placement

QQQ pushes toward the reward target above 109 after a multi-day consolidation near 108.50. The accelerating stop is now applied to aggressively lock in profits because the odds for a reversal have greatly increased. The trader watches the 60-minute breakout in real-time, raising the stop eight times before it gets hit near 109.20. The security reverses in the following session, starting a significant retracement.

The Bottom Line

You can use three types of profit protection stops to lock in profits at different stages in the progression of a successful trade.

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