BarroMetrics Views: How Do I Set Stop Levels? (2)
Ranadagger asked: “could u please also guide as to when do u put ur stop to breakeven and how do u start trailing the same. how much of paper profits do u protect, when do u decide to take partial profits and when do u take complete profits and run.”
I could write a book on the excellent questions you have posed. Let me try to answer them as succinctly as possible.
Firstly, the answers to the questions are founded on my trading philosophy:
- The key principle is the protection of capital through
- Consistent execution of my trading strategy and risk management rules. Once that is achieved
- Pursuit of superior returns.
I implement the philiosophy from the initial stop. Yesterday I introduced the idea of technical stops with filters. This tool is augmented with:
- The stats derived from Maximum Adverse Excursion studies
- The stats derived from the Expectancy Return data and
- The Rule of 3.
I’ll look at Maximum Adverse Excursion today and the rest in subsequent blogs.
I took the idea of MAE from John Sweeeney but I apply differently. From memory (I read the book eons ago), John uses the maximum loss. I don’t like since the maximum loss since it may represent a Black Swan event. Instead I use mean and standard deviation.
The idea is a simple one. What we want to know is: what is likely maximum loss I have to endure before the trade subsequently proves to be a winner?
But rather than define the Maximum Loss in terms of a single loss, I define Maximum Loss as “mean +2 standard deviations” (i.e a theorectical probablility of a 95% occurrence).
This means I need to keep the necessary stats to produce the numbers. But I believe it worthwhile. The stats allow me to finess my stop levels:
- If the technical stop is too close, I increase the stop to just beyond the MAE.
- If the technical stop is much farther than the MAE, as soon as possible, I look for an opportunity to move my stops to just outside the MAE.
More on this next week……