BarroMetrics Views: Stops and their Use II
With the interest in the “Stops and their Use”, I thought I’d cover the topic a little more fully.
I believe hard stops (i.e. stops that are in the market) placed are necessary to guard against catastrophic loss. I place my stops at a point beyond which I am not prepared to accept more loss whatever I may think the market is doing. This stop is partially technical and partially statistical.
- Technical: I place a stop where if hit, my reason for the trade is invalidated. I also incorporate Maximum Adverse Excursion.
- Statistical: The stop needs to be within my money management guidelines. These are governed by my Expectancy Return, the volatility of the market (as measured by the Average True Range [ATR]) and tic value of the instrument. The size of the position is also determined by my assessment of the stage I am in: Flow, Normal or Ebb.
If my technical stop exceeds my guidelines, I pass on the trade.
But stops are not the only way I exit trades. I also use time and structural stops.
By time stops, I mean that for some trades, I set a specific number of days that a trade needs to move mean +1 ATR from entry. The time is set according to the Maximum Adverse Excursion concept (but based on time rather than price) and my assessment of the context.
By structural stops, I mean what the market should not do given the setup (reason) for the trade. My setups have certain price action that ought not to occur if I have read the conditions for the trade correctly.
The problem for the novice trader (and he is the person I am trying to reach in my educational activities) is time and structural stops require experience; this experience the novice has not acquired. So for him, using subjective exits is tantamount to committing trading suicide.
Tomorrow I’ll address the idea of ‘hedging’. While I would never attempt to dissuade anyone from a behaviour that works for him, ‘hedging’ is a subject on which I have strong views.