Stop Losses

As experienced traders know, stop losses are vital when trading, or else one bad trade can blow you out of the water. However many beginners I suspect don't use stops, or if they do, spend little time on them and would rather concentrate on fine tuning their indicators than deciding where the stop should be.

I have just gone back and reviewed my records from a recent account where my returns on that particular strategy were poor. My trades were generally a few days to a couple of weeks. I suspected that I was placing my stops too far away and so reviewed the trades again assuming that I had placed stops at 1 ATR from the entry instead of my original 2.5 ATR. I didn't expect to see such a dramatic improvement (see graph)(The equity curve is not exactly a pretty one in any case!).

Of course the reason is that placing a closer stop enables the money per point to be increased whilst still only risking the same percentage of the account (1% max in my case). The downside is that you may get stopped out more often of course but my figures allowed for that.

I guess the reason for my post is firstly to convince the less experienced traders to spend time looking into their stop positions as it can have a dramatic effect on your account.

And secondly to get the views of the many more experienced traders than myself.

Shanghai said:

As experienced traders know, stop losses are vital when trading, or else one bad trade can blow you out of the water. However many beginners I suspect don't use stops, or if they do, spend little time on them and would rather concentrate on fine tuning their indicators than deciding where the stop should be.

I have just gone back and reviewed my records from a recent account where my returns on that particular strategy were poor. My trades were generally a few days to a couple of weeks. I suspected that I was placing my stops too far away and so reviewed the trades again assuming that I had placed stops at 1 ATR from the entry instead of my original 2.5 ATR. I didn't expect to see such a dramatic improvement (see graph)(The equity curve is not exactly a pretty one in any case!).

Of course the reason is that placing a closer stop enables the money per point to be increased whilst still only risking the same percentage of the account (1% max in my case). The downside is that you may get stopped out more often of course but my figures allowed for that.

I guess the reason for my post is firstly to convince the less experienced traders to spend time looking into their stop positions as it can have a dramatic effect on your account.

And secondly to get the views of the many more experienced traders than myself.

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Thanks for sharing your experiences......

Out of interest, why have you chosen to use this type of Stop?

Chorlton said:

Thanks for sharing your experiences......

Out of interest, why have you chosen to use this type of Stop?

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It is curious because I noticed something similar in this thread:

http://www.trade2win.com/boards/planning-risk-money-management/5128-stop-losses.html#post441174

new_trader said:

It is curious because I noticed something similar in this thread:

http://www.trade2win.com/boards/planning-risk-money-management/5128-stop-losses.html#post441174

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Wow I see what you mean. Remarkably similar to my approach. I could have written that myself (but didn't). There are many places on his forum I should visit but havn't managed to yet.

For Chorlton's question, I like stops based on ATR for 2 simple reasons. Firstly they obvious depend on volatility and so move wider for more volatile stocks. And secondly it means that the stops shold not be where all the other players have their stops ie 1 point below or above the latest low or high, where the pros like to hunt them out.

Shanghai said:

Wow I see what you mean. Remarkably similar to my approach. I could have written that myself (but didn't). There are many places on his forum I should visit but havn't managed to yet.

For Chorlton's question, I like stops based on ATR for 2 simple reasons. Firstly they obvious depend on volatility and so move wider for more volatile stocks. And secondly it means that the stops shold not be where all the other players have their stops ie 1 point below or above the latest low or high, where the pros like to hunt them out.

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Shanghai,

There are a lot of discussions in this forum on the subject of stops. I found the following advice to have been the most useful to me. I have put it to the acid test and it has survived. Therefore I fully endorse it.

The single most important thing you have to concentrate on is limiting losses.You do this by using stops. As you become more proficient at picking winning moves you have to tighten your stop loss policy.

Limiting losses to the absolute minimum is the key. All else is peripheral.

Now that is a simple statement.

If everyone did this, everyone would survive long enough to eventually become proficient. But very few have the self discipline to persist in this way.

I strongly suggest you follow the lead I have just given you.

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One starts at the beginning and finishes at the end. You cannot start at these levels when you are a beginner. It is a matter of refining and reviewing and of self mastery through adversity by sheer dint of will. But anyone who aspires to evantually overcome can do it, it is a matter of determination and focus, and of a burning desire to succeed.

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Without going into deep details I explained that efficient traders use very tight stops because efficient traders get it right many many more times than they get it wrong, that is why they are efficient traders, OK ?

Therefore efficient traders are surprised and shocked when they get it wrong. The fact that they use very tight stops immediately limits losses.

Inefficient traders are apt to use wide stops and some blighters none at all !
They now begin to argue, yes argue, that to use a wide stop is the right thing to do because it allows a position to "breathe" and other nonsenses. When it is pointed out that wide stops used by inefficient traders who get it wrong often and really ought to fiercely control losses, they get abusive, or, begin to argue.

That is why I have so many posts under my belt. I have tried in the past to illustrate lots of ideas. These ideas are immediately recognised by a few who go on to use them beneficiallly which pleases me enoromously. The great majority see fit to argue and argue and do not progress.

I am accused of being among other things, a charlatan, a wordsmith, an autocrat, etc.,

The problem is that a lot of people forget about the message being delivered to them and only concentrate on the way the message is delivered and so miss the content altogether.

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Shanghai said:

I like stops based on ATR for 2 simple reasons. Firstly they obvious depend on volatility and so move wider for more volatile stocks. And secondly it means that the stops shold not be where all the other players have their stops ie 1 point below or above the latest low or high, where the pros like to hunt them out.

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I understand your reasoning as to why you have chosen this type of stop. However, here is something for you to consider....

A trailing stop is a stop which is designed to capture "profit" (hopefully without being whipsawed out). For this reason, something based on volatility like the ATR makes perfect sense.

However, you have commented in your original thread that you also use this stop to calculate position sizing. Maybe you should consider a seperate type of stop used for this purpose which is closer to price than your ATR stop.

Remember that you should be expecting the stock to move higher immediately after entering the trade (afterall that is why you have chosen a specific entry point to enter the trade).... Consequently, any whipsawing shouldn't really come into play at this stage of the trade. If it does, then I would suggest you have entered at the wrong time....

Just my 2 cents....

Chorlton

Chorlton said:

However, you have commented in your original thread that you also use this stop to calculate position sizing. Maybe you should consider a seperate type of stop used for this purpose which is closer to price than your ATR stop.

Remember that you should be expecting the stock to move higher immediately after entering the trade (afterall that is why you have chosen a specific entry point to enter the trade).... Consequently, any whipsawing shouldn't really come into play at this stage of the trade. If it does, then I would suggest you have entered at the wrong time....

Just my 2 cents....

Chorlton

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That's a very good point. At least with the entry you can have some sort of control over the trade. I'm starting to look at my entries a bit more critically these days and I think the approach you outline may be the best of both worlds, still keeping a decent size position but allowing for movement within the trade as it develops.

new_trader said:

Shanghai,

There are a lot of discussions in this forum on the subject of stops. I found the following advice to have been the most useful to me. I have put it to the acid test and it has survived. Therefore I fully endorse it.

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Yes there is some good stuff in there thanks. Seems to me that one of the great assets experienced traders have is the ability to use tight stops and hence increase the reward / risk ratio of each trade. I've found that this aspect doesn't get covered anywhere near as much in the literature as the fine details of technical analysis.

Shanghai said:

That's a very good point. At least with the entry you can have some sort of control over the trade. I'm starting to look at my entries a bit more critically these days and I think the approach you outline may be the best of both worlds, still keeping a decent size position but allowing for movement within the trade as it develops.

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As a side note, on average, I spend the same (if not more!!) development time working on Initial / Trailing Stop and Exit strategies than I do with any other aspect of my systems. From what I've discovered to date, I am happy with this approach........

Good Luck......

Shanghai said:

And secondly to get the views of the many more experienced traders than myself.

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I doubt very much that I fall into this category, but I'll offer some thoughts anyway. :cheesy:
I was at a wedding reception a few weekends ago and got chatting to another guest who is also a trader. (That's the first time I've met another trader by chance!) Anyway, we discussed stops and what he did was to scale out of a losing trade just as many people would scale out of a winning one. He had a hard limit beyond which the trade was definitely no good and he would close out completely. But, before that point, there is a grey area where he might close a percentage of the trade. To illustrate this idea, attached is a 10 minute chart of the Dow from last Friday.
1. The index has sold off heavily from the open.
2. It's also dropped beneath the round number (RN) at 12400 and the previous day's low (PDL) - red line on the chart.
3. It then oscillates sideways around the PDL for the next 5 candles.
For the sake of argument, we decide to go short at the breakdown to new lows beneath the consolidation pattern at 12360 (Blue X hairs). The trade goes against us instantly and price moves back up to close near the close of the previous two candles, forming an ominous 'hammer' type candle in the process. Our hard stop is at the top of the pattern (heavy black line). As things stand - at the close of the entry 10.40 candle, price is still beneath the PDL and the RN. So, there's still hope yet but, after the heavy fall, a sharp pull back is on the cards, so we decide to close half the position if price moves back above the PDL. This occurs on the subsequent 10.50 candle and half the position is covered. It rises and tests the RN and we get ready to close out the other half of the trade as soon as price breaches our hard stop. This doesn't happen and price then falls back down beneath the PDL. The expected breakdown takes place on the 11.00 o'clock candle and the trade moves in our favour to the extent we can not only recover the loss of the first half but, potentially, make a profit on the second half. We end up with a profitable trade, while traders who covered their entire position at the first sign of trouble chalked up a loss.
Hope that all makes sense!
Tim.

timsk,

I think scaling out is a good approach, but I think it is for more advanced traders. Scaling requires trading more than 1 lot and I don't think anyone should be trading more than 1 lot until they have attained a high degree of proficiency. By that time I think it would be preferable to use mental or conditional stops rather than hard/fixed stops. IMO anyway.

Good stuff from timsk and certainly something I will think about. I often get out of a losing trade before it hits my stop when it becomes obvious that the price action is not doing what I expected. If I'm slightly down and my indicators are such that I wouldn't now take on that trade then I wll get out. So with me it tends to be all or nothing rather than scaling out.

One thing I did notice from the review of my trades is that around 90% of my trades that hit a 1ATR stop would also go on to hit a 2.5ATR stop. So having a wider stop gave me little benefit, especially with short trades.

Shanghai said:

One thing I did notice from the review of my trades is that around 90% of my trades that hit a 1ATR stop would also go on to hit a 2.5ATR stop. So having a wider stop gave me little benefit, especially with short trades.

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This is what most newbies would do in the situation...move the wrong end of their trade! If 90% of your trades are having their STOP hit it means you are entering 90% of your trades at the wrong time..:idea:

new_trader said:

This is what most newbies would do in the situation...move the wrong end of their trade! If 90% of your trades are having their STOP hit it means you are entering 90% of your trades at the wrong time..:idea:

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Don't quite understand your point. I'm not saying 90% of my trades are hitting the stop. Far from it. What I'm saying is that of the trades that did hit the 1ATR stop (maybe 25% of my total trades) around 90% went on to hit the 2.5ATR.

Shanghai said:

Don't quite understand your point. I'm not saying 90% of my trades are hitting the stop. Far from it. What I'm saying is that of the trades that did hit the 1ATR stop (maybe 25% of my total trades) around 90% went on to hit the 2.5ATR.

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Yes, I did see that. However I felt my comment is still valid so I didn't edit it. It is what many newbies want to do-Widen stops if they keep getting hit.