The alarming truth about your stop order
If you’re a well-behaved investor … and I’m sure you are … chances are you religiously place a stop order whenever you open a trade.
It’s what we’re taught to do. And we know to measure our risk carefully, and not to step out of that comfort zone.
We’re told that the stop loss is our friend – it’s what keeps us out of trouble. Yet, this ‘friend’ is (without a shadow of a doubt) costing you money. There’s no ‘ifs’ or ‘buts’ about this – stop losses make us poorer. Fact.
But, can we afford to live without them?
Do stops work?
Tests have shown, conclusively, that trading without stop loss will, ultimately be more profitable that trading with one.
If the price moves against us … we can just wait for it to move back in our favour, using a time-based close rather than a price-based one.
Thomas Bulkowski ran a test in which he bought a stock, used a daily trailing stop and left the trade open for a month (unless it was stopped out in the meantime). The results showed clearly that the buy-and-hold method with no stop loss did the best. And that the closer the stop is to the current high, the more money you’ll lose, as stops take us out of trades that are ultimately profitable.
No matter where the stop is placed, it hurts performance. The tighter the stop, the worse the performance. Amazingly, even stops as far as 50% away hurt the performance.
So what’s the point of stops?
This shouldn’t really be shocking news to us (although you may be surprised at just how much your stops cost you).
We know that prices generally come back to a ‘mean’ level …
So, if our pockets are deep enough to ride any tumble on a trade … then we can just wait for our trades to move back into profit.
So, the ultimate scenario for us as traders would be to have unlimited funds … no stops … and to take any profits off the table as soon as we see them …
I’m going to repeat this ‘perfect’ scenario just to be sure you’ve digested it …
• unlimited funds
• no stop level
• take profits immediately (more on profit taking in a moment)
That’s not a strategy that you’ll find in many trading manuals!
And I’m not suggesting that we ordinary mortals trade without stops. The obvious problem is how deep our pockets are … none of us have unlimited funds. So, we have to make do with the funds we do have. And that means that we have to put the brakes on losing trades at some point.
But, how have we travelled so far from this ideal to traders’ obsessions with 2:1 risk-reward rates, letting profits run, and tight stop levels?
If we know that stops cost us money (a bit like paying for an insurance policy), and the tighter the stop, the more we lose … surely we should be trading with the widest stops we can afford?
What’s going on in our brains when we place stop orders?
Many traders rely on stop levels and profit targets as their sole means of exiting a position. Either we hit the target … or we’re stopped out …
Therefore our stop level is placed at the point where our trade plan would be proved ‘wrong’. Just on the wrong side of a support level, for example.
It all sounds very sensible.
Along come the pro traders (these are the ones with deep pockets, who don’t need to fret about their stop distances as much as we do) … our carefully positions stop levels are like sitting ducks to them, ready to be picked off.
It’s no coincidence that our stops get hit, only for markets to turn around.
It’s a paradox – the more we ‘think’ about the placement of our stops – the more vulnerable they tend to be.
And what about our profit targets?
If we’re putting our faith in the markets to generally move back to within their ‘mean’ range, and not to wildly run off … then we need to apply this wisdom to our profit targets too.
Sure, there are times when if we’d left a trade to run, it would have clocked up another 20 … 30 … 100 points … but most of the time, markets move within their expected ranges, and those kinds of profits just aren’t out there.
When the profit is on the table, we should learn to take it, and not obsess about how the distance to our profit target relates to the distance to our stop loss. If you want a data-set to obsess over, focus on your positive expectancy figure (see how you calculate that here).
Am I seriously telling you to cut your winners and let your losers run?
Yes. But with provisos …
If you’re widening your stop levels, that doesn’t mean you should be taking greater risks – adjust your staking levels accordingly. And if you’re making this shift in your trading, you must expect to see a boost in your success rate.
This is a rejection of the ‘hope for the best’ type trade. Whether we have deep pockets or not, we can trade the market with faith and focus in the strategies we’re using, and the mindset of a pro.
To enjoy more content and get it faster Follow @TradersBulletin
JOIN US ...
Get full access to members-only resources, plus my weekly email updates ...
I will NEVER share your details for marketing purposes. Privacy policy
Strategies I'm Using
It has taken 2 years to persuade this market…- These videos show how to make 24% gains in…
As you can see from all the data I've…
Get the low down on the Heikin Ashi Mountain…
5 comments
Paul H
Very interesting post. The double down approach relies on hope i.e. that price will turn when you want it to. Timing is then the main issue. Using a fast stochastic can be very helpful preferably in two time frames separated by a factor of between 3 to 5.
Bill
I like this topic Mark. I myself do not use a stop loss,but I am present at all times when I enter a trade.I will say I have a stop in mind already worked out but like you mentioned my stop has been hit only to turn around which makes me very fortunate for being present during the trade leaving me very much still involved.I will add the reason I do not have a set stop is because like my life I like to be in control of everything I do.Good Post Mark
Ignacio
A brilliant post, thank you!
We have all suffered the pain of using hard stop levels that eventually get hit just before the market turned the way you wanted it… The same monetary loss is far more painful when the market eventually goes what would have been your way than when it continues to push towards levels that would have proven you totally wrong.
Now what I do is to use more mental or time-based stop levels, and build a position accordingly. We never now when the market is going to turn your way, or even if it will. So what I do is to start building a position with a risk in mind and, say, 100 pips stop loss distance or whereabouts. Then if the market continues to go against me, I would, say, double my stake and lift the stop loss “area” to about 50 pips to keep my risk levels the same. I could then just be stopped out eventually. Fine. Or the market can then move towards levels in line with my initial reward-to-risk ratio expectations. Alternatively, the market can turn in my favour as soon as I open the first chunk of my trade. The worst that can happen then is that I end up with a profitable trade with a stake size smaller than initially planned. No problem about it.
I have noticed that by using this more flexible approach, and bending the rules of ‘trading 101 dogma’, my results have improved notably.
Thank you again for the brilliant post!
Ignacio
Just for clarification, the initial 100 stop loss assumes that the ‘real’ stop loss area is, say, 25 pips from the initial entry level. That means that I can build my position cautiously. I would never add to a losing position if the market price went through the original stop loss ‘area’, in this case ‘some’ 25 pips below your first entry.
Mark Rose
Thanks for your feedback and sharing this technique with us. Many traders will hold up their hands in horror the idea of ‘doubling down’ – sure, it’s a terrible habit if you’re doing it in panic or because you won’t admit that you’re wrong. But as part of a risk-management system, it’s perfectly valid.