Stop/Losses - the myth(?)

[nine]

in2uxs

Big difference between a 6 point trailing stop and a 6 point stop loss from entry.

To trail with a 6 pt stop I can agree that it maybe untradeable.

The difference on how you approach the markets, dictates your stop strategy.

I am at the other extreme to your point of view and do not accept that the markets are random.

Day in day out the markets repeat specific patterns that can be traded, not random but precise, the skill of the trader is to identify the patterns as they develop .

If you are in tune with the market, you know where you are right and where you are wrong.

Agreed.

I used to run tests on stops, trailing stops etc. The tests are very useful as a way of understanding the markets better ... but ...

Each market moves somewhat differently and one key to real success is understanding that. And then obviously doing the work to map the movements. So, when I trade I will get a signal, place an entry order and when filled place an entry stop and targets.

I don't trail stops immediately because the entry stop is placed so that (say) 80% of continuation moves from that point won't hit the stop. If I trail it after it moves up 6 points then the percentage might drop to 50% ... because the initial stop is relative to the current formation ... not just an X point dragging stop. I trail the stops relative to price formations as the market moves forward so I will move it in discrete steps not trailing Xx points behind or Xx ATR behind the closing, high or low price.

Try this approach and you might be pleasantly surprised.

 

[dcraig1]

There is some element of truth in what the OP says. As Kiwi pointed out, stops often have a detrimental effect on trading system performance. Kiwi suggests that the lower drawdown of a system with the right stops allows for higher leverage while maintaining the same level of risk. And that can more than compensate for lower basic system performance. I guess this observation is specifically directed at trading futures or forex.

As always, there are many ways of approaching systems. For example use of MOC orders for closing intraday positions that have not hit their target may be a perfectly valid element in an "almost stopless" trading system. Being market neutral is another way.

To get back to the point, stops are used to control risk. But there are other ways of controlling risk and probably diversification is one of the better ones. Trading a portfolio of systems is a conceptually simple way of adopting a different approach to risk management. For example a system with 20% drawdown might induce some discomfort, but in a portfolio of 10 equally weighted systems it is no issue at all. Of course all the systems should not be highly correlated or the benefit is very significantly reduced.

In this way, maximum drawdown does not assume the overriding importance in designing a trading system that it does if that system is the only system traded. Which is not to say that it is not a very important goal, but that it may be possible to trade off drawdown against performance.

IMHO this is where fully automated systems have a really big advantage. Assuming you have the right infrastructure, worthwhile systems and sufficient capital, there is no limit on the number of systems traded. Discretionary traders can't match this.

 

[nine]

Dcraig,

"Kiwi suggests that the lower drawdown of a system with the right stops allows for higher leverage while maintaining the same level of risk. And that can more than compensate for lower basic system performance. I guess this observation is specifically directed at trading futures or forex."

I think my use of the term leverage mislead you. For stocks I would mean that you could take a larger number of shares (assuming that you didn't reach margin limits).

Stridsman has a really good exposition on the effects of stops in "Trading Systems that Work." I'd recommend it to anyone whether system or discretionary trader.