Stops and their Use

BarroMetrics Views: Stops and their Use

The other day, I came across a blog that found that on a R:R of 1:1, a drop at or below 65% and the equity curve became unstable. He also found by adding stops the win rate would cause the win rate to drop and he also found that his stopped out trades were larger than his profits.

Some of  his suggested solutions include reducing leverage and not using stops and trading more often and not using stops. But as he says “Each of these solutions actually will raise a new set of problems”

This leads me to an area that is too often neglected.

It would seem to be that the problem here is the Reward to Risk ratio for the time frame. There is a relationship between:

Timeframe, potential risk, the potential profit, the win rate and loss rate.

The shorter the time frame, the larger win rate needs to be,  and the smaller the R:R needs to be for a stable equity curve. The best example of this are the scalpers. They have large size, large win rate and the R:R is close to 1:1. Other timeframe traders e.g. a monthly trend trader, would have smaller size, smaller win and a higher R:R.

Sometimes the solution to the problem like the one posed lies with tweaking the profit target or changing where the stops are placed. Sometimes, larger stops are called for.

This may just be a personal conviction but as a professional trader, I need to trade a size that given my knowledge and experience will merit the risk. I may be able to buy 100 shares at $10 a share and let it go to $0 if need be, but I would hardly be optimizing my return. If I increase my size enough to make the risk worthwhile, it follows that the risk will be large enough to cause me concern if I trade without a stop.

Now we may need to reduce and use larger stops; or we may need to change where we take profits; or we may need to do both.  The point is not having a stop in the market to guard against a Black Swan event is one risk I’d be unwilling to take.

6 thoughts on “Stops and their Use”

  1. ray, can we really guard against such even by putting stops?

    i mean, putting stops during such even is like putting oil into fire.

    i have to disagree with you. i think there are other ways of protecting ones position and stop orders are usually not a good way.

    cheers

  2. Hi

    We’ll have to agree to disagree.

    I have seen too many accounts wiped out by a failure to protect a position.

    It may be OK not to place stops if you have an iron discipline and exit when a pre-determined event occurs or fails to occur. But for most, failure to place a stop tends to mean holding and hoping.

    The current sideways trading is not helping matters. Many have complained to me that the market stops them out and then goes their way.

    While that will always happen to some extent, many times it is a failure to read the market conditions that leads to this occurrence. Instead of learning about market, too many newbies believe that the best way is not to place stops.

    I know you don’t fall into this camp. But I am speaking about many of the traders who do.

    It only takes one bad trade to wipe out an account – as LTCM found.

  3. Hi Ray, its an interesting point that Coconut raises. I have found hedging at regular periods to be profitable in sideways markets. Theres always a drawdown but also a profit.
    On my larger accounts i still use a stop loss,as an emergency in case of say a heart attack etc. But i find usually there are several opportunities around the PBZ/PSZ to get in and out,and in again ,which may appear to be playing with risk/reward numbers but at least theres some profit if a stop is hit.
    As for LTCM Myron Scholes is currently in Sydney giving a lecture on business.!! cheers Baz

  4. thanks ray, i understand.

    actually i myself had experience wipe out due to not placing stops.

    there is no denial that stops helps to prevent it from happening most of the cases,

    i feel that there are much better ways to protect one self than just stops alone, and as a trader, we have to constantly explore them.

    personally, i had also seen account got into negative when stops were trigle due to big spike in the market.

    the real problem i guess is over leverage rather than not placing stops.

    by the way i do enjoy those disagreement like i disagree with the market as it always helps in my trading.

    thanks.

  5. to baz,

    yes the deeper you explore in the jungle, the more “stuff” you will discovered,

    just beware of any “tigers” that are also around you. we should know how they looks like.

    cheers

  6. “failure to place a stop tends to mean holding and hoping”

    Spot on, Ray. I feel levels for stops, as well as targets, should be rather dictated by the market swings. Even “selecting previous tops & bottoms” as stops doesn’t work lots of times. Of course, the trader, in order to do so, must have a solid grip on measuring the market swings and volatility.

    As a practice, I liken entering a trade to entering a cinema hall. To feel safe in case of emergency, I’d (and many would) like to see exit doors on both the sides of my seat, which is equivalent to having exit price on both sides of the entry price, above and below. From thereon, it’s a no-brainer. I just take whichever comes first. In the absence of any of them, I just don’t trade. PERIOD.

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