I have been going back and forth on how to use my stop loss. I've been considering the method of renowned trader Paul Tudor Jones (in the book "Market Wizards") in which he basically does a series of probes - entering the market (at areas his analysis tells him the market is about to turn around) and then exiting quickly for a small loss - and then re-entering again ... once again using a small SL. He keeps doing this (entering and exiting quickly) until the market takes off in his expected direction for a big win. Here below is a snippet of the interview conducted by the author of the Market Wizards book. It briefly explains how Jones trades:
Q: My impression is that you often implement positions near market turns. Sometimes your precision has been uncanny. What is it about your decision-making process that allows you to get in so close to the turns?
Jones: I have very strong views of the long-run direction of all markets. I also have a very short-term horizon for pain. As a result, frequently, I may try repeated trades from the long side over a period of weeks in a market which continues to move lower.
Q: Is it a matter of doing a series of probes until you finally hit it?
A: Exactly. I consider myself a premier market opportunist. That means I develop an idea on the market and pursue it from a very-low-risk standpoint until I have repeatedly been proven wrong, or until I change my viewpoint.
Q: In other words, it makes a better story to say, Paul Jones buys the T-bond market 2 ticks from the low, rather than, On his fifth try, Paul Jones buys the T-bond market 2 ticks from its low.
A: I think that is certainly part of it. The other part of is that I have always been a swing trader, meaning that I believe the very best money is to be made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle, but I have caught a lot of bottoms and tops. If you are a trend follower trying to catch the profits in the middle of a move, you have to use very wide stops. I'm not comfortable doing that. Also, markets trend only about 15 percent of the time; the rest of the time they move sideways.
The above Paul Tudor Jones method of exiting quickly with a small loss if your trade isn't working out and then later entering again by continuing to use a small stop loss, is something that sounds appealing to me. However, there is a downside to using small stop losses. As a FF member named "Mike Haran" wrote (in an old thread I found) : "Small stops are death by a thousand cuts".
Thus, if small stops are "death by a thousand cuts", then would it be a better idea to do the opposite and have extra-large stops? I've seen traders say a trade needs a lot of room to allow the market to move. The upside is that it will give your trade room to breathe and you will have a higher percentage of wins. Of course, the downside to this is just a few losses can put you fairly deep in the hole (depending on how large your SL is each time).
By the way, my definition of a "large" stop loss is less than 1:1 risk/reward ratio - Especially a ratio such as 100 pip SL & 50 pip target, or 50 pip SL & 25 pip target, etc.
What I'd like to know is:
1. What do you guys think is the best way to trade? Small SL's or large SL's?
2. Is anyone here successful using less than 1:1 ratio? Or do you know of anyone that is successful doing so?
I'm really interested to see the responses to either (or both) of these 2 questions.
Q: My impression is that you often implement positions near market turns. Sometimes your precision has been uncanny. What is it about your decision-making process that allows you to get in so close to the turns?
Jones: I have very strong views of the long-run direction of all markets. I also have a very short-term horizon for pain. As a result, frequently, I may try repeated trades from the long side over a period of weeks in a market which continues to move lower.
Q: Is it a matter of doing a series of probes until you finally hit it?
A: Exactly. I consider myself a premier market opportunist. That means I develop an idea on the market and pursue it from a very-low-risk standpoint until I have repeatedly been proven wrong, or until I change my viewpoint.
Q: In other words, it makes a better story to say, Paul Jones buys the T-bond market 2 ticks from the low, rather than, On his fifth try, Paul Jones buys the T-bond market 2 ticks from its low.
A: I think that is certainly part of it. The other part of is that I have always been a swing trader, meaning that I believe the very best money is to be made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle, but I have caught a lot of bottoms and tops. If you are a trend follower trying to catch the profits in the middle of a move, you have to use very wide stops. I'm not comfortable doing that. Also, markets trend only about 15 percent of the time; the rest of the time they move sideways.
The above Paul Tudor Jones method of exiting quickly with a small loss if your trade isn't working out and then later entering again by continuing to use a small stop loss, is something that sounds appealing to me. However, there is a downside to using small stop losses. As a FF member named "Mike Haran" wrote (in an old thread I found) : "Small stops are death by a thousand cuts".
Thus, if small stops are "death by a thousand cuts", then would it be a better idea to do the opposite and have extra-large stops? I've seen traders say a trade needs a lot of room to allow the market to move. The upside is that it will give your trade room to breathe and you will have a higher percentage of wins. Of course, the downside to this is just a few losses can put you fairly deep in the hole (depending on how large your SL is each time).
By the way, my definition of a "large" stop loss is less than 1:1 risk/reward ratio - Especially a ratio such as 100 pip SL & 50 pip target, or 50 pip SL & 25 pip target, etc.
What I'd like to know is:
1. What do you guys think is the best way to trade? Small SL's or large SL's?
2. Is anyone here successful using less than 1:1 ratio? Or do you know of anyone that is successful doing so?
I'm really interested to see the responses to either (or both) of these 2 questions.
"Success is not a fantasy, it's a formula." - MTI