Article

Why Don’t We Keep Stops?

With everything said and written on the subject of stops, it should be given that everyone is conditioned to keep them religiously even before they start trading. No matter what source a newer trader turns to, utter importance of stops will be underlined and emphasized up to the degree that keeping them is heralded as the ultimate key to success. We all heard adages like “Take care of your losses, profits will take care of themselves”.

Do all the stern warnings work? Not really.

Time and again traders blow their stops, widen them in a course of a trade, hold losing position in false hope it will make them whole. If this destructive behavior continues despite all the warnings, there must be deeply rooted reasons for this. As with most trading flaws, failure to keep stops roots in fundamental misconceptions about the very nature of the market and trading. Such misconceptions cause incorrect psychological makeup which, in turn, results in behavioral patterns harmful for a trader’s performance. In order to re-condition oneself it is necessary to work out fundamental, even philosophical if you will, understanding of the market as an environment in which a trader operates.

Let us list and analyze the misconceptions that cause failure to keep stops.

Right action must result in profit.

This misconception stems from misunderstanding of the very nature of the market as an uncertain environment. Newer trader sees a market as a conglomerate of firm links between reasons and outcomes. In such a conglomerate, every reason results in single possible outcome. The simplest case of such link would be “good news – up, bad news – down”. We know it’s not true – price reacts to news in a wide variety of ways.

Similarly, an inexperienced trader applying the setup he knows “should work” expects every trade to be a winner, providing all the components of the setup are right. Have you ever heard complaints like “Everything was exactly like in that book, yet the trade failed”? That is direct result of this misunderstanding. Everything may be right, yet the trade fails – just because markets work in probabilities and not in certainties.

If a system produces certain percentage of wins over time, it’s just statistics – and, as it is always the case with statistics, it cannot predict an outcome of a particular trade. No matter how good the setup is, any given trade can fail. That’s why it’s imperative for a trader to distinguish between two kinds of losses.

The first kind is a loss caused by a trader’s mistake – failure to follow all the rules of system applied, or impulsive entry without any reason at all. Such losses must be taken as a lesson. The second kind is the case where every piece of puzzle was in place, yet the trade failed – such losses must be written off as a part of trading game, as a tribute to uncertainty of the markets.

Of course, if you identify a component of your trading system that regularly causes trade failure, you can and should tweak your system in order to minimize failures.  However, during the trade a stop must be taken as soon as signal of failure appears. The line of thinking “The setup was so good, it must work eventually” is a disaster waiting to happen.

Failure to perceive the market as an uncertain environment can result in another misconception:

Losses can be eliminated.

In a paradoxical way, this erroneous notion leads to more losses. A trader tweaks his system endlessly trying to get rid of losses completely. In such constant adjusting and re-adjusting, the system evolves into something totally different, losing its original logic, or even stops producing entry signals at all. As a result, a trader either abandons his system, which was not a bad one to begin with, or in a worst case, simply refuses to take losses.  After all, he made his system so perfect by eliminating all the reasons for failures, it just MUST work! Meanwhile, had he stayed with original approach, maybe with some minor tweaks, it would continue producing steady results.

My trade is who I am.

This is one of those hidden subconscious misconceptions that cause us to refuse to take our stop. A trader perceives the result of his trade as a reflection of his personality, his abilities. A trade failure makes him feel as though he is a failure. Winning makes him feel “right”, while losing makes him feel “wrong”. Nobody likes to be a failure, to be wrong. That’s why, in order to avoid being wrong, we refuse to take our stop. You can be right and still lose on this particular trade. You can be wrong and win, too.

It’s important to differ between good and bad trade, and we will be back to this later, in the Random reinforcement part. At this point it’s important to separate your self-perception from the result of your trade. Taking a stop loss, you are stopping your loss – nothing foolish about that. The major trigger for the right approach here is a realization that by accepting the market as an uncertain environment, we already have accepted the possibility of losses. If we haven’t expected the market to work in our favor every time, there is no reason to feel foolish when it doesn’t.

A loss is just a paper loss until it’s taken.

This is a big mistake in thinking. If a loss gets out of hand, it’s very real. It paralyzes you, it clouds your judgment, and it makes you miss plenty of other opportunities. Instead of taking a pre-determined loss and moving on to another trade, you sit and watch your losing one, twitching in pain and feeling remorse. Your chance to take a small stop is long gone. You are agonizing now over big one that is going to deplete your account too much and inflict serious emotional wounds. You hardly notice many other opportunities. The market has moved on, other sectors and stocks are in play, and you still nurture your losing trade, hating it and not being able to finally drop it. At some point you will ask yourself “Why was this trade so important to me? What made me hold onto it?” And this takes us to the next common error:

Putting too much importance into single trade.

A newer trader tends to see each trade as overly important, as if it’s going to make or break him. The market is an endless stream of opportunities. The next trade is right around the corner. No single trade is so important that it would be worth abandoning all other opportunities. Perceive your trading as a process, not as separate events. With the correct approach trading becomes natural, like breathing. Each entry is inhale, each exit is exhale. Breathe in and breathe out.  Don’t choke yourself trying to hold onto each given breath.

Random reinforcement.

This is an important concept to understand. The market is not always rewarding right decisions and punishing bad ones. The practical implication is that a trader runs a risk to stop applying propper techniques if he sees wrong ones being rewarded sometimes. Take a stop, observe a stock reversing and going into profit zone – and you get tempted to skip your stop next time. If you try it and it works, there is significant chance that you continue doing just that – the bad habit gets reinforced. You may win several times by breaking your rules. What happens eventually is that one trade that does not reverse destroys your account. It’s important to define what good and bad trades are. Unlike many think, a good trade is not always a winning trade; a bad trade is not always a losing trade.

– A good trade is a trade where you kept all your rules that you know to be working in a long run. A good trade can be a winning one when the market acts accordingly to what your system indicates. It can be a losing trade when the market acts against it, but it’s still a good trade.

– A bad trade is a trade made against your better judgment, against your rules. It can be a losing trade when a market acts as it “should”. It can be a winning trade when the market rewards your bad judgment, and it can be a very dangerous trap as a bad habit gets reinforced.

The last thing to say in conclusion is that a certain psychological barrier for a trader to overcome to start applying his stops with no hesitation. When this barrier is taken, things suddenly become so clear and automatic that a trader can’t even believe it was ever a problem for him. When this barrier is overcome, you feel that stops became natural part of your trading, that you take them with no slightest hesitation and forget about them instantly, moving on to search for your next trade, that taking stops do not trigger any negative emotions. This is wonderful feeling of total self-control. Not only will it do plenty of good to your trading performance, it’s a very rewarding feeling in itself. 

Vadym Graifer, author of Techniques of Tape Reading (McGraw Hill 2003) and How to Scalp Any Market (2004), is a featured speaker at International Trader's Expos and Financial Forum Conferences. He is the managing partner of RealityTrader.com, a hands-on training company, working with a global community of individuals to achieve high levels of trading success. Vad is a professional trader and an international private trading mentor for RealityTrader.com. He has also published articles and interviews in industry magazines, corporate product newsletters and trading forums.

Apr 24, 2004
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#3
Very Good, I wholly approve, and completely sympathise with the sentiment....However....Valid and well meaning as it is, and indeed well written, the message delivered therein is inevitably doomed to fall on deaf ears yet again.
 
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Vorbis

Active member
Dec 16, 2005
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#4
Excellent article. The is first to which I've given a 10.
 
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c6ackp

Active member
Aug 14, 2004
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#6
Excellent - I like the analogy with breathing - inhale (take the trade) & exhale (take the exit) - fast day trading of very volatile markets feels just like this.
 

Tuffty

Active member
Oct 15, 2003
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#7
Why Don't We Keep Stops?

Quite likely the simple answer is that "We" hasn't had a big enough loss that really hurt enough so taught the lesson properly.
 

FXSCALPER2

Well-known member
Jan 27, 2006
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#8
I have never met anyone one who doesn't use stop losses. Maybe I need to get out more. What I find very common is tight stops. I know people who try to make money trading GBPUSD with a 30 pip stop!!
 

TraderPattern

Active member
Oct 13, 2001
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#10
Thank you Mr Graifer. Your points are well made and are broadly in agreement with my overarching trading philosophies. As a result, given that you make fairly good sense, I pleasurably gave your article a rating of 10/10.

I look forward to more such confirmatory articles from you, which are in broad agreement with my trading intuitions.

Best wishes,
TraderPattern
 
Sep 21, 2005
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#11
FXSCALPER2 said:
I have never met anyone one who doesn't use stop losses. Maybe I need to get out more. What I find very common is tight stops. I know people who try to make money trading GBPUSD with a 30 pip stop!!
You obviously do not put enough emphasis on the accuracy of your entry then, i never use a stop exceeding 30 pips on GBP/USD.

Regards

TMM
 

darktone

Well-known member
Nov 2, 2003
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#15
Stop size is relative to time frame and entry style!:rolleyes:

The most important fact (and the whole point of the article) is that you have an exit plan for all outcomes...... and stick to it!
 
Likes: chump

FXSCALPER2

Well-known member
Jan 27, 2006
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#16
I think people misunderstand what 'stop losses' are. They are there to stop you losing, not just to stop you out. That is what happens to everyone. They use stops that make zero sense. Look at the way the trades are priced on Betonmarkets.com. You will find it impossible to buy a 'one touch' bet for 30 pips because it is very very expensive. You know why? Because they know you will almost certainly win (and they will lose(their position will be the same as putting on a 30 pip stop)). On the other, you will find it is extremely cheap if you want to buy a 'no touch' bet for 30 pips. Why? Because they know you will lose (your position will be the same as a 30 pips stop). Do you think these guys haven't done their maths before embarking on their business?
 

peto

Active member
Dec 12, 2002
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#17
FXSCALPER2 said:
I think people misunderstand what 'stop losses' are.
I should think 30pip stops might well be too tight for someone trading a time frame of days or weeks, looking for perhaps 200 point gains or more.

I think the expressions of surprise you are getting are due to the username you chose, which suggests one who is in and out the market in minutes or less, snaffling half a dozen points or so if skilled or lucky. For such a trader a 30 point loss would be a huge setback, much too big a stop.
 
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Feb 12, 2006
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#18
Great information - Anyone got any information on applying spread to the stop i.e. when spreadbetting an equity trade. I'm looking at Spreadbetting and am interested in the money management calcs that support that and how they differ from pure shares
 
Jul 10, 2003
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#19
Rob, I'm assuming you mean the difference in Money Management with an SB and with a broker? It's the same. Not your likely profit, but the MM calculation.

You look at where you need to set your stop (your risk).

You look at how much of your capital you wish to assign to that risk.

You calculate the number of shares/points you can buy/sell.

You take the trade (if it meets your entry criteria) and set your stop.

The process is the same.

The difference between SB and and Broker is in how much of the move goes into your pocket and how much goes into your intermediary's.