Stops

TheBramble said:

REVERSE ORDER STOPS

You’ll need two accounts (some brokers offer sub-accounts which is the same thing) as you obviously can’t take an opposite trade in the same account as the original trade or that will simply cancel it out – a normal stop/close.

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Some time ago the question of stops was being discussed.

Again, when I commented incisively on it, it served to stimulate the rowdy element as well.

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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The single most important thing you have to concentrate on is limiting losses.
You do this by using stops.

As you become more procicient 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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Because this is a profession and not a pastime, it requires the development of skill. This skill has to be underpinned by knowledge. And this knowledge has to be a vast pool from which to draw, because at any given moment any component of this pool has to be accessible in an instant, without hesitation of any sort, to be able to properly identify what is a real opportunit;y, against a very convinving mirage to be avoided by abstention, or by opposite response, as appropriate.

Now in simple terms, what happens is that none of us are born knowing. If we were, everyone could and would succeed immediately, which is not the case. In consequence of this obstacle, we have to undergo a process of learning to teach ourselves. This is a gradient which can take a very long time to climb, but I promise you, there is an ultimate end to it. It feels like climbing a mountain and finally getting to the summit, where there is no more mountain to climb but the reward is a sort of anticlimax, like the view the climber is entitled to enjoy.

Throughout this long climb, the act itself of climbing causes the climber to teach himself to climb more effectively. A seasoned climber who has climbed many mountains will climb more effectively than a new climber. Let us transpose this idea to trading. What I am imparting to you is that persistent attempts lead to improvement in ability.

Commensurate with the level of ability is the capacity to undertake what we shall call missions. Fortunately there are only three, Long, Short and Abstention. It could be worse, so we must be grateful there are only three possibilities, three options in this regard.

As the level of ability rises, together with the rising of this level and harmonious with it also three things develop. These are choices. Because they are choices they cannot be mechanised, they cannot be fudged, and they cannot be altered, because they are the expression of will. They constitute committment. As they constitute committment, once committed they cannot be undone, which is what makes this profession unique.

But what happens is that through the gaining of proficiency, these three choices do not exactly take on a life of their own, but evolve and become more and more accurate, and more and more refined.

I am specifically referring to Timing, the Point of Entry and the Point of Exit.

When the market begins to "talk to you" instead of just baffling you, the Point of Entry selects itself for you and the Timing is the right one. In consequence of this, you repeatedly and confidently experience the position going in your favour immediately. The stop, which is a crucial safeguard for everybody, is now quickly left behind. With progressive increases in proficiency leading to accurate entry and perfect or near perfect timing, the stop can now be narrowed and squeezed to the limit, taking into account the spread. The other thing that happens is that the exit point becomes clearer and clearer, as you begin to detect exhaustion or imminent reversal.

One percent of capital employed is a vast amount to risk. One fifth of this figure is what you should ultimately aim for or thereabouts.

But in the very early stages in your development as a trader you should begin to cultivate the use of tighter and tighter stops as you progress, because not to do so constitutes dereliction of control. Ultimately risk is about being able to control unforseen losses.

Nearly all of trading is about control. The most important aspect is the control the trader places upon himself to start with. With attainment of progressive proficiency over time, you will see and experience that everything else takes care of itself and falls into place neatly.

The price you have to pay is self governance of absolutely the highest order, and nothing else.

I therefore do not agree with theories involving wide stops or stops placed under the last reversal and such other tripe, I maintain that the trader has to assume complete and utter responsibility for his decision, all else is an excuse.

This attainment of self governance of the highest order is the single most difficult discipline most people have difficulty in mastering. You must take steps to master it, otherwise it will master you, with dire results.

I hope and expect that this comprehensive explanation serves to satisfy your query.

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new_trader said:

Not entirely correct. I used a reverse order stop which worked out well by opening a contract on the back month of the ES in the same account. You need to accept that back month contracts aren't as liquid as front month contracts though.

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0007 said:

Excellent mind-nutrition. Well worth chewing over.

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TheBramble said:

TIMEFRAMES

Why am I mentioning this up front in a post about STOPS?

The Daily chart and the 5 minute chart are not different instruments. ‘They’ do not ‘behave’ differently. They are simply different representations of the same thing – the history of the price. And they have a different audience. Or rather different audiences with different utilisations of any given timeframe. When you hear traders saying they trade this timeframe (TF from here on) or that TF, what they are referring to is the aggregate profile of the price as packaged at the level of granularity. Each bar/candle represents a granule. And that granule can be one year, one month, one week, one day and so on. ‘Normal’ intraday periods are 4 hour, 1 hour, 30 mins 15 mins 5 mins. Some real nutters go to 1 min or even tick charts, but they are easily sedated and cause no harm to the general population of merely insane traders.

Why I feel it’s important to make this seemingly obvious point up front is that a lot of bods get hung up debating which TF is ‘better’. You hear arguments such as ‘trends aren’t valid in sub-daily TFs’ and ‘the monthly sets the primary trend and pivot levels’. The thing is, there are enough traders operating at each of these TFs to provide you with a reasonably solid probabilistic base to accurately employ most technical analysis tools and to provide you with a better than 50% chance of getting a trade through to profit – regardless of your method or system. I’ll admit to personally believing that the fundamentals dictate the longer TFs while technicals lead the shorter TFs, but that’s just my view. Of course, the shorter TFs lead the longer TFs in that any major change in trend in the higher TFs has to start in the shorter. Has to start on the tick actually. Luckily, my view makes no difference to you and does not detract or enhance one iota the following. Which is why you can just relax and take it all in.

So when you hear of the daily being in an up trend and the 4 hourly being down and the 5 minute being flat – they’re not different instruments, just different representations of the historical behaviour of the price in that past when viewed at those levels of granularity.

They have significance only because others think they have significance.

If you want to test that hypothesis, try using your Fib retracement calculations on a 5 hour chart and try using the closing values of an 18 hour chart as key pivot points. You wont have much company up there…

So, what I’m saying is, don’t get hung up in which TF, just use them with an eye to how everyone else is probably using them, and with an even keener eye to how the big boys are expecting everyone else to be expecting everyone else to use them.

A lot of people think each lower TF operates within the context of the higher one. It’s an amusing abstraction and may represent reality for all I know, but regardless of your intellectual capability to recognise this for what it is or is not, why not play along with them and make some money too? They may be clowns, but there are a awful lot of them and they have money. Lots of it. And you want it.

Here’s the thing. In any one timeframe, they imagine there are specific price levels at which supply or demand will come into the market or will dry up and that this will impact price action, either slowing its descent or ascent. They may be right. Who cares? Whatever, they call these levels are called Support and Resistance. They are in actuality singular fractures in the space-time-price-phase continuum and only take on the distinct ’S’ or the ‘R’ context depending on the direction from which the price approaches them, but lets pretend they’re two different things for now . What YOU might want to consider doing is paying attention to what they think these levels are. In each TF. In each currency pair you’re thinking of playing with. (Works the same for stocks and indices and futures, but lets stick with currencies for now. Besides, the stocks, indices and futures traders have volume and open interest to assist them so they are in a better place anyway. Sod them for now).

Now, it would be just wonderful if you could keep in your head all these S/R levels in each TF. There are potentially many such levels in each TF. And there’s no reason you couldn’t. If you can’t manage that (wuss), you can note them physically on all your charts. Of course, an easier method is to just focus on one or maybe two pairs. Or alternatively, just note the current price level for the pairs you are interested in and note the nearest S/R levels in each TF. Here’s the deal. When the price gets close to any of these S/R levels in any one TF, you potentially have a pause, a strong breakthrough or a reversal of direction. It beats the boring all trending you get all the rest of the time. When this level on any given TF coincides with an S/R level in one or more other TFs for that same pair, the probability is even greater for a long pause or a reversal or a strong breakthrough. What’s this got to do with STOPS? Well, S/R levels are pretty good place to take stock and decide whether to carry on or reverse or hang around for a while. Up to you whether you want to 2nd guess it or wait for the move (with 3 options at a S/R level and only one of them profitable for you personally, it’s your call of course, but this is real basic probability…), but at least with S/R levels, you have the ability to focus on the price when it gets close and get on with other more interesting stuff when it isn’t. Nuff said.

And now, finally, to the meat of the post - STOPS.

STOPS

I make no distinction between a hard (preset) stop which is physically set at or very shortly after the trade is placed and executed automatically by your evil manipulative broker if the price reaches that preset level, and a soft (mental) stop which is manually activated by you at a level determined prior to or after placing the trade. (Mental as in it’s just an aide memoire and you will need to take specific physical action to exit the trade rather than mental as in it’s a bloody ridiculous place to put a stop). Both hard and soft stops are going to give you the same result. They get you out of a trade that hasn’t performed as well as your excellent analysis indicated it should. But the calculation of the stop and its placement were part of your excellent analysis and you should be proud for being smart enough to know where being sufficiently wrong enough was enough wrong for you to want out. You can also, more often than random chance would permit, be equally proud if not amazed that your stop was the precise level where the price would reverse and go in the originally intended direction. (Here’s a hint: Next time, don’t place the trade until the price is actually at the level where you would have put the stop had you taken the trade when you initially wanted to. This is typically 2 hours and 25 minutes earlier if you’re running 5 min charts).

One small point about changing stops after the trade is on. There’s a good reason the majority of successful traders who use stops would suggest it’s best not to change stops after the trade is on. And that reason is you’re less likely to be able to rationally reconfigure and repotimise a stop when you’re bleeding capital. And the times you typically want to consider resetting your stop is when it’s just about to get hit – i..e. you’re bleeding capital. And at that point you’re not normally thinking about reducing your risk, quite the opposite. Emotions come into play at those times which will prevent you more often than not from doing what’s really best for your trading capital long term.

It is of course quite feasible that you would want to reconsider your stop placement in order to reduce your risk (bring it in closer and tighter) if momentum or time issue indicate that is the correct form of action, but that will, or should be part of your trading plan before you enter the trade. Or if it wasn’t, after this trade, it will become so.

NO STOPS

This absolutely is the best form of stop. Without stops of any kind you never have to lose any money. The only prerequisite is that you get all your trades right. 100%. Forever. All of them. All the time. This is possible, quite seriously it is possible, but highly improbable. Unless you have made a deal with the Devil or have by other means guaranteed and certified you will always get all your trades right, this probably isn’t the best option. It will only take the one trade to show you quite effectively that do have a stop even if you thought you didn’t – when your account hits zero. Actually, a point a little way before that if your broker isn’t dead or asleep (and as they never sleep because they are “The Undead” your luck is pretty much out on that score).

Don’t think I am being merely probabilistic about traders being able to get all of their trades into profit. We exist. LOL. But unless you’ve never yet had a losing trade out of the 10,000+ or so you’ve taken, don’t ever imagine for a single moment you will ever be one of them.

WIDE STOPS

Aka ‘Giving the trade time to mature/room to breathe’.

The genuinely comforting thing about wide stops is that you can be awfully wrong about your trade direction and/or timing, and still feel vindicated that you had the foresight to recognise the possibility of being so incredibly wrong by allowing it an inordinate amount of slack before conceding defeat.

The downside to this is that you need, if you have any sense at all, to base your position size on your risk and you’re only going to be able to take one tenth the position with a 100 pip stop as you will with a 10 pip stop. More room to breathe. Indeed. Less reward too. And usually, more time (much more time) needed to make the target in relation the TF being traded.

I’ve tried all these methods and I have to say the gratification in not being stopped out 6 million pips away from your entry on the one or two occasions it worked out well doesn’t really make up for the paltry rewards when your trades do run to target – several centuries later. And you really can wait what seems like decades for them to come good.

There needs to be a realistic risk:reward in all your trades. No point risking 100 pips for a potential 20 pip reward. So the wider the stop the larger the target and the commensurately (normally) longer the lifespan of the trade. Even if you don’t think price is totally random, you probably have to agree that the longer you’re ‘live’ in the market – the greater is your exposure to risk. Not many consider time exposure as a positive thing. Unless they’re selling you option premium…

So you allow a 200 pip risk and you wait for your 1000 pip reward which takes 10 times as long and you get the same absolute profit.

My view is that stop type is largely if not totally an aspect of personal trader physio-psychology and not an academic or empirical issue. And is it most definitely a ‘physio’ thing as well as psychological. Taking loss is taking pain, physical hurt and mental disequilibrium. If you need room to be right even when you’re wrong, even if it takes your entire life – wide stops are the way to go.

TIGHT STOPS

Which do you think is easier for most traders (most traders HATE to take any losses), to take one 60 pip stop or to take ten 6 pip losses?

I personally like to be in profit as soon as I get into a trade. I like to play hit and run all the way up or down the trend (or the range). Dipping in and out.

If you decide EURUSD is going down and al the technicals are ‘right’ - and you go in and it goes against you by say 6 pips plus spread (just a for instance), there’s very little pain in killing that trade. Several times in fact. Until you get it right and it immediately goes into profit. Or until the conditions change and the short analysis no longer holds. And you move on.

You see, for me, there’s absolutely no difference between an initial stop and an ‘in play’ stop. I’m just in for the ride along some part of the trend. Many parts of the trend usually. Initiating a trade and it going 50 pips against me is just the same loss as being 150 pips up in a trade and letting it slip back to just 100 pips profit.

Getting in and staying in require constant positive movement into profitable territory. If it moves against you – get out. If and when it resume its ‘expected’ directional movement, get back in. The pips spread you pay each time is a very small insurance premium.

I know traders who will use a 2 or even 4XDaily ATR to stop themselves out. It works for them. It would make me cry. I’d rather make lots of commissions for my broker in lots of smaller trades on the way along the trend than risk a large pullback. But that’s just me. Fits my phsyio-psychological trading needs perfectly.

The downside, if it is really a downside, is that you’re making lots of smaller trades and relatively lots of money for your broker. But also for you though.

The upside is that you’re ‘in’ the market for shorter periods of time, so time exposure is smaller, and most of the time you’re in the market, your trades are in positive territory.

Another upside is that your losses, though frequent, though possibly at times even more numerous than your profitable trades, are small and easy to handle and total far les than you total profits.

You also get to manage your trades far more proactively which means more screen time. Upside or downside? What else were you planning to do today?

SCALING OUT STOPS

This isn’t a bad option. Somewhere between wide stops and tight stops. It says ‘I know I’m wrong, but I might not be totally wrong’. This will decrease your exposure, lock in some loss, but not all. You ain’t dead yet.

You set scale out levels at a number of intervals, say 3 or 4. When the price goes against you to stop level 1, you scale out one quarter your position. Stop level 2, another quarter, etc. Or you could split it over just 3 or 2 levels.

This has some merit and gives you more control over your losses and takes some of the heat out of being emotionally totally wrong. You can always put that quarter position back on when it comes back, if it ever does come back.

It also means you are hitting relatively (for you) small losses on the way at each level and these are much easier to take emotionally and financially

The downside is that you have far more work in calculating your trade position and bail out levels and you need more effort and time to manage your trade. It’s a trade off, but one that many find worthwhile.

REVERSE ORDER STOPS

This is similar spiritually to the NO STOPS style and absolutely the same in financial terms as a normal STOP. You simply take an opposite position to you current trade. You lock in your loss. You’ll need two accounts (some brokers offer sub-accounts which is the same thing) as you obviously can’t take an opposite trade in the same account as the original trade or that will simply cancel it out – a normal stop/close.

These seem attractive on the face of it. You get to keep your original trade (gone wrong – however temporarily) and you also befit from the pair’s current wilful disobedience in going in the ‘wrong’ direction by profiting on the 2nd trade taken in that direction. The net result is of course the same as if you had taken the loss. The only difference is that you have funds tied up for the duration and you are faced with how to unwind two positions now rather than one.

You can wait until the ‘temporary glitch’ burns itself out and take your profit on the second (reverse order) trade and then wait for your original trade to get into profit having already booked your 2nd leg profits. Of course, there’s nothing to stop the price reversing again. At which pint you can always put on another reverse position trade. You can whipsaw around all year long taking contra trades and making small profits and breakevens and lots of pips commission for your broker. Ad Infinitum. But that’s the thing, there is no infinity with your trading capital. You can play hit and run all the way down (if your original position was Long) and bank profits on your reverse position shorts all the way, but all the time, your exposure on your original Long is eating massively into your margin. And there’s no guarantee it’ll ever come right. You’re just putting off what you should have addressed way back. And al those profits you banked on the contra trade(s) on the way, guess what – they wont be taken into consideration when you see the size of your loss on your main trade. Been there. So you don’t need to. Unless you like pain. In which case, I fully recommend it.

I’ve outlined a few approached you can take to setting (and not setting) stops. While I’ve been less than covert in explaining my current preferred approach to stop setting you shouldn’t take this as an endorsement for any specific style. My entire thrust has been to suggest you need to explore what best fits your personal style, approach. Method and system.

Hope this helps.

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zupcon said:

The optimum stop for a momentum strategy isnt the same as the optimum stop for a trend re entry strategy, and the only way anyone's going to "optimise" their stops is either by analysis of historical data, or through trial and error gained by experience.

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zupcon said:

The problem with all this for the new trader is determining the definition of "tight" and "wide" with respect to his or her chosen timeframe, strategy, and market conditions, and unfortunately there is no one size fits all solution. The optimum stop for a momentum strategy isnt the same as the optimum stop for a trend re entry strategy, and the only way anyone's going to "optimise" their stops is either by analysis of historical data, or through trial and error gained by experience.

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Splitlink said:

That may be stating the obvious but I wonder how many traders study those bar lengths before placing their stops?

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new_trader said:

Hmmm...Yes and no. You are focusing on optimising stop size where I think the focus should be on optimising entries and exits. Why should the strategy matter? I can't grasp this concept. Your aim is to correctly determine turning points in the market whether they are long pull trends, intermediate trends or immediate trends. If you use a wide stop on a trade it is probably because you are entering when you ought to be patient instead.

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new_trader said:

Hmmm...Yes and no. You are focusing on optimising stop size where I think the focus should be on optimising entries and exits. Why should the strategy matter? I can't grasp this concept. Your aim is to correctly determine turning points in the market whether they are long pull trends, intermediate trends or immediate trends. If you use a wide stop on a trade it is probably because you are entering when you ought to be patient instead.

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Mr. Charts said:

Nice post, TheBramble

ATR using the default 14 setting is a blunt tool, imo.
I think it's better to think of a maximum probable stop at 2.5 to 3 times ATR as range expansion can often be almost violent and disproportionate to what has already happened and to expect a following candle to be limited to the ATR is far too risky. Using an ATR x 3 will encompass 95% of the ensuing move on the same timeframe.

For me such a large move is far too much anyway and I firmly believe that if an instrument is moving away from the direction of your trade on actual momentum, (as distinct from pausing, wiggling, minor noise), then you should simply exit the trade.

Why on earth sit there watching yourself lose money hoping or wishing it will turn back in the right direction?
That, to me is like paying money to the market for the opportunity to be proved right.

Another approach is to look at the maximum range - between the low and the high - of any candle on the day thus far, and regard that as being the maximum likely move.

Accuracy in entry and exit is preferable and although poor timing can be mitigated, the more accurate the timing, the better the bottom line in the long run.

Having an ATR on a chart must affect position size, although personally I prefer trading lower ATR stocks as they are often more reliable and rarely move strongly against you, thus minimising risk.

Having said that, I personally prefer much tighter stops than using ATR affords.
Richard

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Paul71 said:

Hi Richard.

Ok, so there is a price, let's say this price is being sold into from a higher price. So it goes through and back up to the given price and maybe breaks upside to test buying sentiment, all the clues are in the book and volume.

Why do traders have losing trades?

Is it to do with stop size, or lapses of concentration, or both?

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Splitlink said:

I think that it is waiting too long for the price to reverse, when one should have the nerve and discipline (don't worry---I'm just as bad! ) to enter right on the end of the bars, where the other traders' stoplosses (should) cut in. The price, immediately moves in your direction (theory) and you stick your stop below your entry. This is why the experts say that stops can be close because the chances are that they will not be triggered.

Split

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