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Mastering the Art of Stop Loss

Quoting Ajm
I'd have to disagree with both Dopey and ekiden on this.

A trader's first priority is to protect the money in his account. If you have to determine ratio or profit or stop lose after the fact, you are not in control of the trade.
You have a stop-loss to control your trade. And you manage money buy calculating how much you are risking per trade by position sizing (Read Van Tharp). You don't control much else... You hear traders say entrance is the least important aspect of trading.. this is true.. the most important part is your exits.

Quote
The main tools for this are correct trade entry point and a stop loss.
If you are entering a trade, your system, experience and probably a bit of instinct shoud tell you that the entry point is correct. You should know the amount of pips, percentage or whatever you are expecting to take as profit. If you are sure of this, take the trade. If you are not sure of this then you should not be making the trade. You may as well spin a coin and say head's I buy, tails I sell.
So, what you are saying that, on average, your instinct is your edge? If that's true, then per 100 trades, you should have more winners than losers. If so, then you are a great trader.

Quote
Your risk / reward ratio tells you how far from your entry point you need to set your stop loss to give you protection from a bad trade. We can't predict the market but we can at least take an educated guess.
If I use risk reward as a gauge to where I should exit, then I'm imposing what I'm thinking on the market. If that's true and is successful, please share with us.

Quote
On a different and unrelated thread, but useful for an example, is a system on breakouts. This uses boxes for showing various parts of the PA indicating different things, with the intention I assume, of determining where the breakout will occur. My reading of one of the last charts told me that if they'd just apply a few of trendlines on instead, it would show them the PA is moving into a wedge with an underlining support level. From that infomation you should be about 99% sure of the direction of the breakout and the approximate point it will do...
Again, if the strategy yields 99% winning based on 1:1 risk reward ratio, then that's a great system. You can almost risk 50% of your capital on that strategy. But that percentage is largely based on gut feelings if I read it correctly.

I'm not trying to put you down, but I'm very interested in what you have to say. Is this based on a large number of trades? (maybe at least 30 trades...not large, but that's a good start).

I think to test anything objectively, one has to understand statistics, but maybe I'm wrong.

A quick note
If the market is random (don't agree or disagree yet), and then if you have a 1:1 risk reward trade, you should have a 50% chance of winning and losing on average (ignoring spread).

With the same assumption, if you have a 1:2 risk reward ratio, you will have more losers than winners just by randomness alone.

Now "traders" can test their strategies effectiveness by using the 1:1 RR. If your strategy is superior, you should have more winners than losers, otherwise, you are doing no better than a coin toss.
Chicky...I'd like to humbly add my thoughts on stoploss placement and management:

First off I consider myself a trend trader that looks for NEW trends on entry. Thus most of my entries are counter trend (unless I am catching a pull back). That is to say I trade both sides of the market because I cannot say which entry will be the new trend direction (neither can anyone else that I know of).

I trade large time frames, daily/weekly, using an intraday trigger. Thus timing is very important to my strategy. I do not enter at the popular resistance or support level, I wait to see if intraday price action will confirm the level with a price action signal (hammer, engulfer, dark cloud, etc)

On entry I will then calculate a 14 day ATR and double it. This is my initial stop level. I then calculate 2% of my account for this amount.

Now I do not allow my stop to be hit unless some surprise happens while I'm asleep. If price closes on the wrong side of the price action signal I exit with a loss of less than 2%...my own stats show an average ACTUAL loss of 1-1.3% per trade. If the price closes beyond the originating price action signal (thereby confirming it) I move the stop to the extreme low (longs) or high (shorts) and LEAVE IT THERE. This effectively reduces my risk usually down to 0.7% or sometimes even less.

From here I look for 2% profit and take all but a single mini lot off. I then move the stop up to break even on this small position and let it ride. I have taken profit and still have a small position going...

Every year there is at least one good trend that will allow me to have several (up to 5) of these small positions riding, while I have still take profit on the shorter runs.

I keep these positions going until I see unmistakable trend exhaustion signals...divergence, etc on the weekly chart then exit them for a large risk-to-reward. Some of these are as much as 12:1.

Each time a new position is added all stops come up to the same level so all are stopped out together.

I have no set ratio of profit to stoploss except that I am looking for 2% on each trade. If I get that GREAT...if I don't I take profit off the table regardless of the RRR...its a matter of saying to myself..."how much of my profit am I willing to see melt away?" That usually makes for an effortless decision.
Great thread, I look forward to further reading as it develops.

A couple of thoughts from a trend trader are:

When price is ranging a s/l should be outside the range, until price breaks the range at which time a BE stop can be placed and subsequently s/l trailed closer to price as volatility decreases and liquidity increases in the market as the trend develops.

Once profit is equal or greater to initial risk then it is often a good time to get an itchy trigger finger and take a 1R profit if price threatens to retrace back and take profit gained. Unless of course you are going for some nice 2:1+ move.

I am not a fan of AJM's words:

"Be prepared to reject a trade even if your system says it is perfect, unless "you" are certain."


Rejecting trades that are perfect according to your system is surely a path to certain failure. The only time that "you" could be certain about a trade is when you are backtesting old data. Traders deal in uncertainties and until you become psychologically resigned to the fact then you surely won't make it in this game. If the entry has an edge that has been statistically varified then you HAVE to take a perfect trade - and live with the uncertainty.


Thanks again for a good thread.
Enter Signature
Quoting Chicky
Hi
1. I see the ratio as a byproduct afterwards and isn't factored in during a trade. I've wasted too much time trying to calculate R:R ratios.
2. Away from volatility.. and away from the hunters.
3. I only take profit to cover losses occured in acquiring that position(pair). Hopefully I only have to take minimal profits.
4. No cons. Pros: limit losses.
5. Reality. Plot round # trailing stops, for example (100/200pip trailing). Those are some of the easiest to grab.. in my observations.
6. Volatility-based trailing stops are 'OK'. They're still hunted almost as much as set pip-value trails though.

A good scenario would be if you were to fade the result of an accomplished stop-hunt and place the new order's stop the distance hunted, then it'd be too costly for the hunter's to grab your SL (at least in the near-term). Think about time between orders too.. trailing stops go for days/weeks as they accumulate bigger and bigger. SL hunting is done much faster so that most retail participants are able to reenter or take advantage of it.
  • Post #25
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  • Edited 1:05am Aug 30, 2011 12:05am | Edited 1:05am
years ago there was no stop loss,at least traders didnt use them,u traded the mrkt,when wrong ,u got out ,it was discipline that kept u alive,i haven't accepted stop losses as an option,i think they are a crutch,and when using them i get killed by a million stops,i trade the 3 points on the chart along with a tl,and apply that to several mrkts and when 2 or 3 line up ,i press,and get out when all 3 break the res or supp,means i'm wrong,if right i ride it to the next point and see if it bounces or goes thru,i usuallly reduce at that next point and wait to see the momentum of the bounce(dead cat or strong)the entries should be based on strong signals,lay ups ,and should work out the majority of the time,when trading s/r you are quick to identify a misread and you get out....http://imgur.com/NW73W
  • Post #26
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  • Edited 1:07am Aug 30, 2011 12:25am | Edited 1:07am
scalping is much harder but the same principle applies,the chart from left to right was all initially sell entries for example,at the points described on the previous chart,there was recent res or support,you enter at these areas and if it continues to rise ,you take a loss,the stop is that the resistance didnt hold,if it holds within a set number of pips, you stay in,the fact that every trade goes against you at first is more true than false....now if you get 5 setups a day and they are each a 300 dollar winner,then 300 should be your max stop,so that the next winner is a scratch for 2 trades and you still have a chance to net 3 winners on the day..as mentioned earlier,have never learned to use stops,but think they should be based on several factors,not the pain of losing preset amount,ie 200,the concentration on losses psychologicaly is counter productive and imho,causes your focus to be on losing.hope to here more reasons to use stops as i've primarily been stopped out on good trades with close stops,while trying to find a use for them,and very few times ,a handful,was the outlier max pain stop ever hit...http://imgur.com/sWVqs
Quoting ekiden
You have a stop-loss to control your trade. And you manage money buy calculating how much you are risking per trade by position sizing (Read Van Tharp). You don't control much else... You hear traders say entrance is the least important aspect of trading.. this is true.. the most important part is your exits.

So, what you are saying that, on average, your instinct is your edge? If that's true, then per 100 trades, you should have more winners than losers. If so, then you are a great trader.

If I use risk reward as a gauge to where I should...
The stop loss is there to simply control any losses. I control my entry by deciding at what price I am prepared to place a trade. I have a criteria for deciding on where that should be, if the criteria is not met, I don't place the trade. To me the entry is an important part of the trade.

To me, sticking rigidly to my trading plan is my edge. It's when you deviate from what you know will work in the long run that things can go wrong. Instinct I think, developes from knowledge and experience

Using the R/R is not imposing what I think on the market, it is imposing on myself, a level of restraint.

My experience is based on studying, then 6 months dummy trading before, about 18 months ago starting a small live account. I trade on average 10 trades a week.

On the market being random, I would say overall, no, it is keept within limits by the large central banks and intrested institutions. Pure randomness would have no limiting factor.

AJM
I know absolutely everything, unfortunately 99.99% of what I know is wrong!
Quoting Sarythsaya
Great thread, I look forward to further reading as it develops.

(Snipped)

I am not a fan of AJM's words:

"Be prepared to reject a trade even if your system says it is perfect, unless "you" are certain."


Rejecting trades that are perfect according to your system is surely a path to certain failure. The only time that "you" could be certain about a trade is when you are backtesting old data. Traders deal in uncertainties and until you become psychologically resigned to the fact then you surely won't make it in this game. If the entry...
I think I need to clarify on that quote.

If a system says that if this fast MA crosses that slow MA in an upwards direction, buy. If it crosses downwards, sell.

What a lot of them don't say, is that this is just an indication that a "possible" trade is available. What I am saying is that you need to confirm to yourself by another method that the trade is valid.

Below is a quote from my trading plan.

"Before I execute a long or short trade, I will quickly scan the daily, 4 hour and 1 hour time frames for support and resistance levels nearby. I will also have my trend lines, fib levels and chart patterns marked and plotted in advance so I know whether I should take or reject a trade."

I think we are basiscally in agreement.

AJN
I know absolutely everything, unfortunately 99.99% of what I know is wrong!
  • Post #29
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  • Edited 5:12pm Aug 30, 2011 5:01pm | Edited 5:12pm
Quoting Ajm
Using the R/R is not imposing what I think on the market, it is imposing on myself, a level of restraint.
So having a RR of 1:2 is a restraint on your part? Restraint from 1:3? I'm not quite sure what this means. Suppose you stick to a trade with 1:2 RR and your target is at 10 year high (just for argument sake), how is that not imposing your belief on the market? By having a rigid risk reward ratio before hand, you absolutely belief that the target is going to get hit regardless of what the market is doing... otherwise, why get into that position? On the other hand, you get in a trade where your target is resistance and stop-loss is a support, there are chances that both are going to get hit, but the question is which one first. If you enter close to the support, your RR ratio is going to be above 1, if you enter a trade close to resistance, it's going to be below 1.


Quote
My experience is based on studying, then 6 months dummy trading before, about 18 months ago starting a small live account. I trade on average 10 trades a week.
I think what counts is the total number of trades of the same exact strategy. Then run a statistical test to see if it is significant not. Otherwise, you cannot be objective in your trading strategies. You can trade for years without knowing if your strategy is based on outlier or it actually has some edge (winning above 50% if RR is 1:1).

Quote
On the market being random, I would say overall, no, it is keept within limits by the large central banks and intrested institutions. Pure randomness would have no limiting factor.

It's not random because it is comprised of players in the market. But if you don't know what the heck they are going to do, it might as well be random from a trader's perspective. It's like being in a fight... you know who the puncher is, you just can't predict with certainty which fist is going to hit you first.

Thanks for the lively discussion.
We are trading probabilities. We ask ourselves, “given this set of circumstances and this amount of information, what is the price going to do?”
We place trades on the expectation of it going where we think (perhaps hope is a better term), this is only our best guess, because it is a guess, we place a stop loss to cover our backsides. The market will go where it goes, there is no imposition from us, it's too big and decentralised.


I consider myself a novice trader. According to one figure I've seen bandied about 95% of novice traders fail. So if I want to succeed, I need to know the reasons they fail and then work out a strategy to try and avoid this fate.


Two of these reasons were, no care for risk and money management and another was greed. I'll limit to these two or we could risk going wildly off topic.


Risk and money management meant not being wiped out by one or two bad trades but, being able to carry on and recover, even after a string of losses.
So, I use up to a maximum percentage of my available account per trade and protect the downside, with a stop loss, positioned so that it is always less than I hope to gain.


Greed to me, was the need to make as much money as quickly as possible, (which could also lead to over-trading). My counter to this is to make money slowly, and hopefully consistently. I therefore have a set profit target per trade and limit the number of trades to as few as possible. These few need to be highly reliable by looking for converging factors. Look for the best set-ups and if nothing is on the chart, don't trade. The PT could have been less but on a small starting capital I had to have a reasonbly compounding rate of increase to make it worthwhile and a lower TP would have meant more trades.


As I said the restraint is on myself.
I probably have an overly disciplined approach to trading, but it's an approach that works for me.




AJN
I know absolutely everything, unfortunately 99.99% of what I know is wrong!
just my points .. doesnt necessary fit to others trading styles.. thou

1. What should be ratio between SL and TP and why? (Logic of whatever is recommended)

RR ratios automatically puts you into wrong shoes as the all known saying
cut your losses short and let profits run .. is allready limited due the TP!

so waht ever the market gives you take it... no TPs

ie my RR is Risk = max.5% Reward = Infinity (beat that!)

2. Where to place sls and why?

based on technicals ie swing lows , highs etc.
but the entry TF is where u put your Mental SL (MSL)
and on the next higher TF you place a disatster stop.. (SL)

mental SL help u to judge the market and price behaviour towards your MSL
if it looks like a shakeout u stay in the trade if not get out !

3. How to scale down or close a trade?

close full position , based on a change in market condition against my open positions.... or SL @BE+ gets hit..

4. Cons and pros of SLs

SL hit! your out of the game ..
+good if u are wrong
-bad if its a shakeout

MSL lets judge u how to act ..
+gives you more room to judge the markets action
while price is near or at the MSL
- if u are wrong an price flushes to fast u might get a worse price to get out
so a sound and sharp analysis or feedback from the market should be done
or recieved .. in order to get out before the shit hits the fan...

5. SL hunting...... Is it myth or reality?

SL hunting is probably doable but happens mostly on its own ..
due SL cascades get triggered ..


6. Trailing stops

i dont use them
Quoting PrymeTyme
RR ratios automatically puts you into wrong shoes as the all known saying
cut your losses short and let profits run .. is allready limited due the TP!

so waht ever the market gives you take it... no TPs

ie my RR is Risk = max.5% Reward = Infinity (beat that!)
Can you clarify on the "Reward = Infinity" part? I usually hear that shorting stock is risky because there's a limit to price going down, but price can go up to infinity, but I've yet to see that infinity (except for few stocks like Berkshire Hathaway which seems like infinity. I'd say less than 1% from the universe of stocks). But technically speaking, the short critics are correct, but evidence says the probability is so lop sided that the argument holds true in rare instances, but true nevertheless.

For Forex, prices act less like stocks and can be extremely volatile. To have definite stop-loss and no target, your stop-loss will get hit more often than to go to "infinity" (based on your experience, correct me if I'm wrong). Your clarification would help greatly. Thank you.
Hi ekiden


well the Infinity Part is just theoretical .. thou

what i was trying to say is you limit your profits with a TP in place

example...


you buy the support of a range .. now typical TP would be resistance

but what if price breaks out ? your TP gets hit and price starts a new bullish rallie wich could last several years ! so u limited your profit .. as the market is actually willing to give you more ... and the trend could theroretical last forever .. but we know that it probably doesent .. and is the trend changes.. u can rake in some several thousand profits.. instead of fifty...

however if price bounces off resistance .. u close your long position..

u see u have more room to let the market tell you if you want to stay in the trade our get out !... and yes its based on expirience.. when to do what..

btw .. moving your SL to BE and u dont have to worry if SL gets hit more often the price goes to infinity but that depends on position and trade management... but homeruns will come .. and then u just have to add positions as it unfolds... just like the equity millipede .. from PIPeasy ...


cheers
Quoting ekiden
Can you clarify on the "Reward = Infinity" part? I usually hear that shorting stock is risky because there's a limit to price going down, but price can go up to infinity, but I've yet to see that infinity (except for few stocks like Berkshire Hathaway which seems like infinity. I'd say less than 1% from the universe of stocks). But technically speaking, the short critics are correct, but evidence says the probability is so lop sided that the argument holds true in rare instances, but true nevertheless.

For Forex, prices act less like stocks...
Very good points.

Currencies, stocks and commodities have a minimum value and logically their price should never go below their respective minimum values. For example no matter what happens, price of gold cannot go to zero. It bound to have a minimum value because of its physical existence. Same is true for all other commodities. Similarly stocks also represent net (tangible or intangible) assets of a company and therefore should have some minimum value. However, it is possible that net realizable value of a company's net assets falls below zero. A currency is promissory note, an unconditional promise to pay on demand certain value to the bearer of that note. The minimum value of a currency note should therefore be the value of gold reseve kept against that currency. Again there is a very remote possibility that for some reason a currency fails and bearer of that currency note get nothing or almost nothing.

People who suggest there is limit to downside but no limit to upside used the above mentioned reasons to support their theory. How far is that true? I don't know. But the thing I know is that market forces pull and push price (or parity) of a currency in either direction and those forces have now become the primary factors deciding parity of a currency. To me, minimum value of currency is too little. Yes, commodities are a totally different story. I would be more than happy to set a margin call on my oil deals at $25 a barrel or gold at $380 an ounce. But will not do the same on my euro deals even at 50 US cents, simply because it can go below half a dollar.
The Thief of Wall Street
I figured I'd add to this great thread and briefly revive it after almost 3+ years of rest.

A simple concept I learned throughout the professional years that a lot of traders are unclear about are stops and limits.

Stops and Limits, many just don't know the difference.

Stops: guarantee execution, not price. e.g. stop loss at 100 pips? cool I will get execution at 100 pips or worse (usually the latter b/c your broker is not in your business which is trading) So when a black swan e.g. 3rd sdev move hits, maybe you get stopped at best 200 pips later: slippage, fast market conditions etc etc whatever the broker says for an excuse, execution right? Didn't have to be exactly at 100.

Limits: guarantee price, not execution. e.g. buy limit at 1.55? price at 1.56? o.k. price retraces to 1.5497 real fast filled at that price, gg broker ate his own spread, one of the rare times a broker is to your benefit. So your price, limit order is guaranteed to be that or better, however it doesn't mean you will get filled (on rare instances).

Stop and absorb these concepts and apply them to your trading mindset, the better you understand, the better you will become.

Cheers

~FXC
"Diversification is an excuse for a lack of talent" ~FXC
Quoting FXCapitalist
I figured I'd add to this great thread and briefly revive it after almost 3+ years of rest. A simple concept I learned throughout the professional years that a lot of traders are unclear about are stops and limits. Stops and Limits, many just don't know the difference. Stops: guarantee execution, not price. e.g. stop loss at 100 pips? cool I will get execution at 100 pips or worse (usually the latter b/c your broker is not in your business which is trading) So when a black swan e.g. 3rd sdev move hits, maybe you get stopped at best 200 pips later:...
Hello FxCapitalist,

Thanks for pointing out the advantages of using Stops and Limits.

So Limits offer great advantage vis a vis the price fills and to a certain extent we can increase the odds of getting filed if we place it little higher. I mean if the original intent was a buy limit at 1.5500, perhaps we enter 1.5510...

What would you advise in terms of Stop Loss for dealing with Black Swan Events? Price can go in a jiify crossing the limit price, so Are market orders the only way?

Thanks
Quoting aaven
{quote} Hello FxCapitalist, Thanks for pointing out the advantages of using Stops and Limits. So Limits offer great advantage vis a vis the price fills and to a certain extent we can increase the odds of getting filed if we place it little higher. I mean if the original intent was a buy limit at 1.5500, perhaps we enter 1.5510... What would you advise in terms of Stop Loss for dealing with Black Swan Events? Price can go in a jiify crossing the limit price, so Are market orders the only way? Thanks
If your intent was buy limit at 1.5500 why would you want to enter at 1.5510 you need to decide what price you really want because limit orders are utilized for precision it's either 1.5500 or 1.5510. that's like intentional slippage of 10 pips at your own discretion. The odds of you getting filled are unknown unless you really have a good grasp of institutional order flow. That's on a different level.

As for black swans no stop or manual order can protect you from it due to potential liquidity issues. All you can do is pray your account can survive the event because I've seen stops blown past 100-400 pips before with rejected orders.

Cheers hope that helps.
"Diversification is an excuse for a lack of talent" ~FXC
Quoting FXCapitalist
{quote} If your intent was buy limit at 1.5500 why would you want to enter at 1.5510 you need to decide what price you really want because limit orders are utilized for precision it's either 1.5500 or 1.5510. that's like intentional slippage of 10 pips at your own discretion. The odds of you getting filled are unknown unless you really have a good grasp of institutional order flow. That's on a different level. As for black swans no stop or manual order can protect you from it due to potential liquidity issues. All you can do is pray your account...
Thanks Fx Capitalist for taking the time to answer my query. Much appreciated.
Quoting aaven
{quote} Thanks Fx Capitalist for taking the time to answer my query. Much appreciated.
Yea np.
"Diversification is an excuse for a lack of talent" ~FXC
Quoting Chicky
Hi, Countless threads on Forex Factory offer trading strategies. Some good others not so good. I think this is about time we start threads on trading tactics that can go with one's trading method. Setting Stop Losses is one of the arts require mastering. Following is some food for thought. You may like to take a bite before posting 1. What should be ratio between SL and TP and why? (Logic of whatever is recommended) 2. Where to place sls and why? 3. How to scale down or close a trade? 4. Cons and pros of SLs 5. SL hunting...... Is it myth or reality?...

Let me post my opinions based on my scalping experience and trading method.

1. What should be ratio between SL and TP and why? (Logic of whatever is recommended)


There is should not be any ratio because market doesn't care about our risk reward ratio. It will go where ever it wants and how much it wants thus we need to obtain the ability to harvest profits that market is offering us which means you don't fix your profit area.

2. Where to place sls and why?

Stop loss is for a reason. It means it will protect our capital if trade goes against us. Why we use stop loss ? If I have a trade plan and I enter in the market then according to analysis market SHOULD go in predicted direction and not move around against me. This is why we place stop loss in case our analysis become invalid stop loss protects our capital from further loss.


3. How to scale down or close a trade?

A-How to scale down ?

Move stop loss to recent swings in order to protect profits.


B-How to close a trade ?

Depends in what environment I am trading. If I know a trend is very long term then I'll just keep moving my stop loss at swings but if I know the trend is short term then I'll be taking partial profits.


4. Cons and pros of SLs

Pros:

A=In case of sudden spike against us, our capital or profit will be safe.
B=Good for trade management

Cons:

If used improperly then:

A=Price comes and hit your stop loss then goes where you predicted price would go
B=Stop loss is too far letting you feel safe but actually you have no stop loss at all


5. SL hunting...... Is it myth or reality?

I don't have much information about this as long as your broker and platform is good you'll be fine from such scenarios.


6. Traiing stops

Automatic trailing stop:

Useful when I am away from trading desk for long time.
Very bad to use every time because trade management is done based on volatility and price behavior while automatic trail stop doesn't calculate any such thing.

Manual trailing stop:

Very useful in trade management. In case price spikes down our trade profit will be safe.
Allows us to catch huge profits and keeping our trade safe.
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