nizar said:
Mag,
when does an initial stop loss become a trailing one for you? as in, when do u start moving up your stop to protect increasing levels of profit?
are most of your exits from the stock hitting your stop or from some other exit criteria?
i used to think that the only reason traders would sell is if a stock hit their stop. ie. they wanna keep hold of a winning position as long as the trend allows, and consequently the stop should be placed in a position which would indicate that
Hello Nizar,
Your question is deceptively simple, but the answer is very involved.
Ok, simple answers: I tend to aim to trade the main trend, and exit where I think an impulse is at risk (this is usually a half exit, but sometimes a full exit). Once the trend resumes or near where I think it will resume I look to re-enter the position.
I also sometimes play the counter trends looking for sharp gains with puts (I did this a lot with BHP and RIO as they pulled back during this last bull run from 2003 – very dangerous though, you really need to know what you are doing here and be very nimble. Need to know your option theory too if using them.). If trading long options (puts or calls), you need to sell on strength (“McLaren-ism”).
Now, let’s examine this in more detail since this is not as straight forward as it looks. As for stop losses, these are usually driven by failure criteria, time and often by discretionary exits if it looks wrong to me oddly enough. I do often have a technical stop too, but this is carefully placed – I try to imagine what I would do if I was on the opposite side trying to take stops out, and place my stop accordingly – in a not very obvious place.
But behind this, we’re really talking about money management issues and developing a trading plan to suit your approach/system, so this is very much horses for courses. As you can imagine there are quite a few variables involved, based on what market you trade, what instrument you use (shares, options, CFDs, futures, warrants, bonds, and other derivatives such as structured financial notes etc), your risk profile, and your timeframe, not to mention your trading style.
If we’re talking Stop losses specifically, my approach varies depending on a range of these variables. Don’t forget that timeframe and instrument should play a big part in how you structure your trading plan and money management approach. But the core inputs are:
• Technical Exit – profit, loss, and partial exit (to lock in profit).
• Time: set a time target for exit - especially if using options.
• Discretionary: pattern invalidation/failure or some kind of reason that puts the trade at risk.
• Position size
• Instrument
• Market
“Cut the losers” – how tight should your stop really be?
Think about situations like the one Daffy (tech) describes in post 357. After you’ve entered long on a pull back (expecting a resumption of a bull trend), the stock goes flying down hard – in these situations many people jump out while the professional players shove the price down to shake out longs with stops set too tightly.
Then once enough stops are taken out, the strong buying continues all the way up, then they sell it down again to take their profits. Look at the bar on Daffy’s “Ouch” day. This is pretty much the way I read that bar. Gapped down at open, moved back up strongly, then was sold off towards the close. Classic bar.
Snake was spot on in drawing attention to this. If you had set a stop loss too tightly, you would have been taken out, only to see the underlying rally all the way back in the direction you thought it would go. There are times to use tight stops, and times not to. Time frame is a critical element as is the position size involved. Sometimes it makes sense to trade for longer periods, and reduce position size to allow a wider stop. Fully agree with Snake’s observations here.
Money Management:
This in my view revolves around two key concepts – 1) Risk and Reward, and 2) Probabilities. In my view, you need to be aware of how much you are actually risking, and what the likely rewards are. Then I also believe that you need to assess the probability of a range of possible outcomes to the best of your ability, and what the net effect would be to your position. But this is just my view, some choose to ignore one or both or these concerns (at their peril).
A key element in money management is position size. I keep reading these ridiculous comments about only risking 1% of capital because someone has set a stop loss at a specific price. Hogwash. If you put up $10,000 into a share purchase, you are actually risking $10,000. If for some reason a trading halt is called, and the stock goes into liquidation, it is possible for you to lose the entire capital staked. This can happen. Sure, it is not probable, but it is possible. Think about this.
Also, it is highly possible for a stock to gap down way below a “stop loss” and keep going. In a panic move, it may not be possible to exit until the stock has hit a price way over the fabled 1% stop loss. In my view this is really a misnomer about stop losses. Of course I’m assuming a long share type position here, the reverse of course applies to short positions (if short and the underlying gaps up), and leveraged instruments also can behave differently depending on the instrument used.
This is where probability estimation comes in. It’s a bit like an insurance actuary assigning risk and examining the reward for doing so. This is essential in my view to determine which trades to avoid, as much as identifying the ones to take.
“Let the winners Run” – the important half of the story!
Another sloppy mantra that is chanted ad nauseum is the concept of “letting the winners run” – what a dangerous notion this is if it is not combined with Mark Douglas’ gem: “I pay myself as the market makes money available to me”. What he’s saying lines up with McLaren’s wonderful story of learning “how to take a profit”. I’m sick to death of people putting this kind of “truism” up without explaining the important half - Knowing when to get out and not overstay the position.
I remember being really bullish on a banking stock a few years ago, got the entry spot on and saw my options double overnight, and continue for 2 more trading days, didn’t take my profits, then saw the stock plummet and take over a month to get back to the same level, resulting in a loss because I didn’t believe it was going down. Hence I learned my lesson, and now set technical partial profit exits (ala McLaren), or if unsure of the technical exit identify doubling my position as an exit half target. Then I also set failure criteria and profit stops for the remaining half.
Playing the Market:
People seem to forget that this is a highly competitive arena where the big guys have huge $$$ targets to achieve, and are out to take your money. They have deployed considerable resources to the sole pursuit of taking money from any source they can find – this includes YOU!
There are also professional traders who depend on winning at this game to make a living. They treat this pursuit as a serious business and have to be 100% committed to making consistent profits. Then there are the amateurs and mums and dads.
If you don’t understand that there are all sorts of manipulative tricks that some of these guys play to make a quick buck out of the majority, then you are naive, and probably will be their next meal.
There are as snake points out different trading objectives, such as long term trend following, counter trend trading (usually quite short since it is against the main trend), day trading etc. All very relevant considerations into the mix.
The way I trade, I assess the probabilities, and interpret the chart and define exit criteria of taking profits when the trade is at risk, or where there is a good chance that an impulse may end and retrace against the main trend. You have to know how to take a profit, as much as know how to take a loss. Two sides of the coin, and half the equation that is often missed if you are position/swing trading (I tend to see these terms as pretty much interchangeable depending on the definition).
As you can imagine, we’re skirting a lot of involved issues here, and there are subtleties and tactics, and methods that we could talk about for hours on this subject, but I hope this helps to illuminate some of the issues in this first cut at the subject.
Regards
Magdoran