This is a guest post from David Nelson – for learning the fundamentals on how to buy penny stocks and penny stock investing or trading.

The stop loss is the friend of professional traders, the foe of those that like to brag about the multi-bagger home run of a stock trade, and my personal hell. Not because I don’t agree that they are good for me and my stock returns, but because the stress of picking the right stop loss can drive me batty, much more than even choosing what stocks to buy in the first place. No one likes getting stopped out of a trade because it basically means they lost. However, only losing a little is what keeps you trading, versus losing it all in 7 days (like I did the first time.) Here are my personal rules and trading tips that make the choosing easier and keep the trades happening.

Average Daily Range

The average daily range (ADR) is how much a stock moved per day over the last x number of days. I tend to choose 2 times the 13 days but this can certainly be suited to taste. This is not what the average closing price was for the last 13 days, but how much the highest high and lowest lows were over that time. If this is the average it moves than twice the average will take you out of the range of what I call stock price vibration.

Flickr photo by pushandplay

Next Major Resistance

I also choose the next major resistance point below my ADR point. I know that stock prices will test both the support and resistance levels in the course of choosing a trend. If the price is in a channel and the channel is below the ADR then I will put my stop loss below the channel line. If the channel line is inside the ADR or it’s not clearly channeling I will choose the next major support line from either a moving average, past price point, or Fibonacci retracement. If the stock breaks the ADR and this support line then I clearly want out of the trade as it appears to be turning against me.

Choosing your stop loss helps you face the real amount of risk you have in a given trade. One you place that line on the paper you might realize that your trade isn’t as good as you thought it was either because the stock is just too volatile, there is no sign of support beneath you, or there is too large of resistance ahead of you relative to what you’re risking.  It’s also important to note that when you invest in penny stocks and other thinly traded stocks, a stop loss is not always possible though a mental stop loss is still prudent for any type of investment.

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