Have you ever noticed in Las Vegas that even on odds of 51% (blackjack) the house is making a killing? The reason is this; you trade your valuable and limited money, that you only have so much of, for worthless chips. The casino has lots of plastic chips, in fact an endless supply. As the game proceed both you and the house swing up and down, but at some point, if you play long enough, statistics say you will temporarily be down so low you can buy no more chips. You are bust, and you go home broke and the casino has ALL of your money. If you could have played on, statistically a new swing upward would be likely, but you must stop when you are broke. This changes the odds way in the house's favor.
I set up a simple simulation on a computer with a game 60% in my favor. It would randomly pick number 1 - 10, if it was 1-6 I win. If it was 7-10 the house wins. It turns out if I don't have enough money to start I will go bust before the enviable win that 60% odds will eventual give me.
In the book Trade Your Way to Financial Freedom this same experiment is listed as proof for money management. But if you think about it, a stop loss order is the same concept as trading too much of your account. With a stop loss you are tilting the odds in the house's favor. A stop can be though of as a mini "going bust" where you are forced out. A stop, in effect, is a forced sell low, after you bought high.
I ran a simulation on a simple breakout trading system. The data I used was from a very volatile and down trending market, but the system made money. Then I programmed in a stop loss. The tighter the stop, the more the system lost. It was not until I set the stop at 2.5 times the average daily price moment, that I got no hits on the stop, and the system became profitable again.
Are stops really a good idea? I would like to hear from experienced traders.
I set up a simple simulation on a computer with a game 60% in my favor. It would randomly pick number 1 - 10, if it was 1-6 I win. If it was 7-10 the house wins. It turns out if I don't have enough money to start I will go bust before the enviable win that 60% odds will eventual give me.
In the book Trade Your Way to Financial Freedom this same experiment is listed as proof for money management. But if you think about it, a stop loss order is the same concept as trading too much of your account. With a stop loss you are tilting the odds in the house's favor. A stop can be though of as a mini "going bust" where you are forced out. A stop, in effect, is a forced sell low, after you bought high.
I ran a simulation on a simple breakout trading system. The data I used was from a very volatile and down trending market, but the system made money. Then I programmed in a stop loss. The tighter the stop, the more the system lost. It was not until I set the stop at 2.5 times the average daily price moment, that I got no hits on the stop, and the system became profitable again.
Are stops really a good idea? I would like to hear from experienced traders.