Stops - Why So Important?

[tech/a]

An interesting contrast.
TT has open profits and realized losses [10% stoplosses realized]
I have realized profits and open losses.

You have also locked in Tax at full rate. All of my most profitable trades have been held over 12 mths.All the little profits and little losses are at the normal tax rate.Tax is a definate issue that needs to be addressed by traders.

If the market corrects hard, as we had in May, TT's profits could shrink, my losses could grow. The outcome would be thus;

TT has stops hit, exiting trades, reducing profits.
I have increased drawdown, no action taken.

TT responds to market risk via stoplosses.
Market risk is irrelevant to my model, I evaluate economic risk.

Very few of T/T's stops will be hit as few trades are in their infancy.
However T/T's EXITS could well be hit. Realising profit. If you place a 180day EMA of the LOW on all of those charts held for any length of time you'll notice that the $$s given back in a heavy correction are in relation to the trade minimal.

I never have to worry about initial drawdown to the degree a trader with no stop has to.

The Fundamental case of NO STOP

What amuses me is that a Fundamental analyst can and will be so wrong re the valuation of a stock yet so stubborn in thinking that he will sit through drawdowns that halve the value of the company invested in.

Now if a company halves in value from the time it is seen as UNDERVALUED then something is seriously wrong with the company---and I know nothing about it/them.

As it settles into a price that the market accepts I just cant see how todays valuation has ANY bearing on the valuation it was given by the analyst when it was twice its current price.

SOMETHING FUNDAMENTALLY BASED has to have happened for such a crash in price.Yet its ignored.

What you and other fundamental analysts here seem to be saying is that at no time can their fundamental valuation or more to the point "PERCIEVED VALUATION" alter or be incorrect. (Unless they are not holding the stock) It seems that once the stock is held then the Fundamental Analysis carried out sticks perminently to the stock---if it fails then the Market has it wrong NOT THE ANALYST!

Opportunity cost is massive let alone real profit erosion from massive drawdown.
This drawdown is very real.It has and does erode enormous amounts from open profit.

CALL......$4.76........................$2.82...... ...................(-40.7%)
SAFM......$26.45.....................$26.34....... . ................[0.0%]
FORD......$10.74.....................$5.08....... .................(-52.7%)

CTT......$4.00.......................$2.63........ ..................(-34.2%)
CQB......$17.47.....................$13.52........ .................(-22.6%)
TOL......$29.78.....................$27.41........ .................(-7.9%)


SGTL....$10.30.....................$4.65...... .....................(-54.8%)
EVCI....$1.44.......................$0.50........ ...................(-63.9%)

SEPR....$92.50.................................... ..............................
OFIX....$37.44....................$43.67.......... ..................+16.6%
WON....$6.65.....................$6.59............ ...................0.0%

CAR....$18.48....................$20.44........... ..................+10.6%

Aggregate......................................... ....................[-17.0%]


Closed Trades

ISSC...................+8.1%
HNR....................+21.6%
EGY....................+61.8%
LRT....................+29.2%
KND....................+34.0%
GKIS..................+37.8%
DRYS..................+34.0%
UST...................+35.2% [not inc. dividends]
NAFC.................+29.0%

Aggregate..............+32.3%

Lets allocate $10,000 a trade.

9 sold 32.3% av profit.---$29,070
Say 50% tax rate---$14535 nett.

12 losers $120,000 x 17% = $20,400.un realised loss

Of the 12 open trades only 2 are working for your portfolio.

{Honestly the illusion of profit is as obvious as the illusion of undervaluation in those which have decreased in price by 40% or more.} Sorry I just cant fathom this mentality although I understand what your attempting to do.

But as you can see your building a stable of losing trades.
If you were that confident of the method these now BARGAINS should be averaged down heavily---why arent you doing this? Why wouldnt you if your valuation was correct---then now its plainly rediculously undervalued!!.

To not do this flies in the face of the initial analysis---does it not?

In my view your work is the best example SUPPORTING STOP LOSSES.

Yes duc I know what your attempting to do.---think your snafoood.

But for all the flak you are one of the few willing to put your neck on the line.
Its pretty hard when it isnt performing---that in itself deserves respect.

By the way T/Ts 30% is not Compounded.
If I was to add that component it has turned $100,000 to $390,000 in 4 yrs or 97.5% a year.
Add leverage (Margin) and thats 250% a year.ie $ original $30,000 now $320,000 after paying back margin loan.--(All Raw figures.)

 

[constable]

Constable.

Setting your stop and as such your risk can be calculated in 1000s of ways.
Yours is one way.

In AUZ's case the obvious stop is 1 tick below last Thursdays low..066
Risk is .007.or 72000 shares (by the way the $500 would need to be the trade risk not the portfolio risk or Portfolio heat.) This would be my way using Bar analysis.

Portfolio heat is the accumulation of risk on all trades in your portfolio if all were stopped out at the one time.If placing a stop in an arbitory fashion then Portfolio heat maybe an issue,as would the number of trades in a portfolio.
10 trades with a 5% total risk would be high

But then we are beyond this discussion.

My calculation was with a portfolio of 100k using only .5% risk on one trade maximum loss of $500 on any on trade . (quite conservative)
95592 shares @ .08 cents total cost of $7407.36.
Could place up to 13.5 trades at this price and the heat would be $6750
or 6.75 % ... is that what you mean by heat?

I dont mind having close to a zero tolerance with losses but obviously will get stopped out more. last 2 weeks i ve placed 42 trades - 24 wins 16 losses with losses being 35% of win value.
Thinking this method may be a little less conservative than my current style . Really i guess at the end of the day greatly depends on the quality of your stock selection - mine for last 2 weeks have picked 63.6% winners . Short stops i know have cost about 6 trades or nearly 10 % more winners.
I will try running with this method for a week or so .

 

[tech/a]

Those who rarely use stop losses tend to suddenly start trading for the long term. We have all seen these posts after a stock suddenly falls out of bed.

If you are a trader who needs a stick of dynamite to make you sell then a stop loss is vital. If you trade a reasonable number of shares then you can set different stop losses for each parcel of the same stock.

One favourite method, which I am using with one stock, is to put in a selling price for different parcels. One parcel sold at $3.60 and the second at $3.70, and I have prices set all the way up to $4.50 in eight more parcels. All you have to do is state how many shares you wish to sell and the minimum price and the order remains for 28 days. If you keep on your toes you can vary or cancel at any time or and add trailing stop losses. Market depth often shows up the plans of some in less traded stocks but is harder to spot in the likes of the ASX 20.

There are many variations of the above on buying and selling that can act in a bullish or bearish vein. The orders can remain either on or off screen.

Nice idea.
You could and I have done the same thing with buys.


Each trade in the one stock has its own criteria.
How do you find brokearge,I find I have to have reasonable parcel sizes to make it profitable.IE 10K.

For instance a long held stock could have 4 buys in it all with different criteria.
I have heard of one or a few stocks becoming a specialist trading method in themselves.

 

[tech/a]

My calculation was with a portfolio of 100k using only .5% risk on one trade maximum loss of $500 on any on trade . (quite conservative)
95592 shares @ .08 cents total cost of $7407.36.
Could place up to 13.5 trades at this price and the heat would be $6750
or 6.75 % ... is that what you mean by heat?

I dont mind having close to a zero tolerance with losses but obviously will get stopped out more. last 2 weeks i ve placed 42 trades - 24 wins 16 losses with losses being 35% of win value.
Thinking this method may be a little less conservative than my current style . Really i guess at the end of the day greatly depends on the quality of your stock selection - mine for last 2 weeks have picked 63.6% winners . Short stops i know have cost about 6 trades or nearly 10 % more winners.
I will try running with this method for a week or so .

Heat would be dependant on number of stocks in your portfolio and the risk in each stock if all closed at the one time.
10 stocks with .5% risk is 5% heat on portfolio---quite acceptable.

Your win rate is good and with a .5% stop loss would think youd have a good expectancy.

 

[constable]

Your win rate is good and with a .5% stop loss would think youd have a good expectancy.

Yes i can imagine you've seen many come and go under, hopefully will be here same time next year with 2400 wins and 1600 losses!

 

[ducati916]

tech/a

You have also locked in Tax at full rate. All of my most profitable trades have been held over 12 mths.All the little profits and little losses are at the normal tax rate.Tax is a definate issue that needs to be addressed by traders.

A valid point, however, your later assumptions are incorrect.
I am an Incorporated Hedge Fund in the Channel Islands [remember I'm British] and thus tax free. But tax is a very important area to be addressed.

But as you can see your building a stable of losing trades.
If you were that confident of the method these now BARGAINS should be averaged down heavily---why arent you doing this? Why wouldnt you if your valuation was correct---then now its plainly rediculously undervalued!!.

To not do this flies in the face of the initial analysis---does it not?

Which brings us directly to an alternative risk management tool, which is the AIM methodology. As such, I will average down on trades, and actively trade them where appropriate, I just have not bothered to post all the trade management involved partly due to the workload, partly due to the peanuts.
But in essence, AIM replaces the stoploss as a risk management tool.

As such, the posted results give a pretty close representation, or the worst case scenario that you could expect following a valuation methodology.
It is still early days yet, I still have two years before the methodology can be called into question.

jog on
d998

 

[noirua]

Nice idea.
You could and I have done the same thing with buys.


Each trade in the one stock has its own criteria.
How do you find brokearge,I find I have to have reasonable parcel sizes to make it profitable.IE 10K.

For instance a long held stock could have 4 buys in it all with different criteria.
I have heard of one or a few stocks becoming a specialist trading method in themselves.

The stock I have started selling is now over 900% up on its 2003 price and as you can guess has considerable value and makes it worthwhile selling in a number of lots.

 

[Out Too Soon]

.

One favourite method, which I am using with one stock, is to put in a selling price for different parcels. One parcel sold at $3.60 and the second at $3.70, and I have prices set all the way up to $4.50 in eight more parcels.

That sounds like a good idea if you have enough invested. Thanks Noirua, I'll consider that in future.

I just started experimenting with stop losses last week, set them too close & found myself out of ZFX, KZL, CBH, AGS & JMS, all at a profit but of cause it was the wrong move because they're all up again.
I'll set lower, more varied & split stop losses in the future. The details of which, as yet, elude me.

The hardest part of stop losses for a beginner is the tug of war between not wanting to lose to much gain & not wanting to lose to much gain.
Hey! you know what I mean. :

 

[nizar]

The stock I have started selling is now over 900% up on its 2003 price

Thats a good effort, well done

 

[MichaelD]

There are as many ways to set a stop as there are entry methodologies. I'll now talk about the functions all stops perform as a trade progresses.

Stops can be one of three things; an initial stop, a breakeven stop, or a trailing stop.

An initial stop is designed to protect your capital. It is the stop you set on trade entry. It is set at a point below your entry point at which you will accept that the trade is not going your way and it is time to get out of the trade with a small loss rather than watching it turn into a large loss. Basically, it is the point you set BEFORE you take the trade where you will accept that you are wrong about the trade.

As a trade progresses in your favour, at some point you will want to move the stop up to your initial entry point, making it a breakeven stop. At this stage, if the trade reverses and hits your stop you'll get out at approximately even.

Once the trade progresses in your favour further, your next goal is to lock in the profits that are accumulating. A very common newbie error is to watch a trade take off to the stratosphere and then watch it come right back down again without doing anything about it. A trailing stop trails profitable price action, ensuring that if the trade reverses past the stop that you will exit with a profit.

 

[tech/a]

OR a time stop. Really for longer term trades.

Michael when would you move your stop to Breakeven?
Does the time/price frame alter for you within the timeframe traded?
Do/how do you consider position sizing at the time of placing a stop?
How does timeframe influence your stop?
Do you trigger your stop on violation or confirmation of violation of the stop?

 

[MichaelD]

OR a time stop. Really for longer term trades.

I haven't seen any evidence that proves a time stop for a long term system makes any difference to profitability.

I'd be concerned that a time stop may in fact prove to be counterproductive, like so many other things, as it would take you out of a stock which is languishing in stage 1 and just about to break out to stage 2.

If there is any solid evidence that a time stop is beneficial, then I'm certainly interested in hearing about it.

For my short term system - a time stop is research in progress. In this case the postulate is that leaving a stock languishing between the initial stop and breakeven results in an opportunity cost due to the short timeframe involved.

Michael when would you move your stop to Breakeven?
Does the time/price frame alter for you within the timeframe traded?

Long term I use a trailing stop only, so that moves to breakeven in due course for trades that go my way.

Short term the simple answer is "as quickly as possible".

Do/how do you consider position sizing at the time of placing a stop?

The other way round. I'll place the stop and then I'll position size based on where the stop is.

How does timeframe influence your stop?

As above.

Do you trigger your stop on violation or confirmation of violation of the stop?

On violation of the stop. That's what was backtested so that's what I trade. I want trades that go my way, not ones that might go my way if I give them another chance.

 

[nizar]

In AUZ's case the obvious stop is 1 tick below last Thursdays low..066
Risk is .007.or 72000 shares (by the way the $500 would need to be the trade risk not the portfolio risk or Portfolio heat.) This would be my way using Bar analysis.

tech,

whats your view about not setting your stop in an obvious place? does it really matter?

Michael as well please

(maybe you guys didnt see this post from a few days ago)

 

[emma]

Trailing stops for short term trades - this is my conundrum at the moment as I have recently had two trades with good open profits, stopped out at a much lower price. What methods do forum members use to protect their profits on short term trades? Thanks Michael for starting this thread.

 

[Burnham]

Trailing stops for short term trades - this is my conundrum at the moment as I have recently had two trades with good open profits, stopped out at a much lower price. What methods do forum members use to protect their profits on short term trades? Thanks Michael for starting this thread.

Beat me to it Emma, same question here.

"plan the trade " = stop on entry @ 10% and trailing stop of 10% from highest close thereafter.

10% can be tight especially on low issue stock or sub 50c type trades where a few trades down can take you out - this applies more particularly to the trail rather than entry. (eg; STX & AKK trail stops taken out today - both remain attractive fundamentaly ( in my view ) but "trade the plan" .... grrr !

Have looked at application of trail % kicking in only when X % target reached after entry to adjust for false breaks down but the KISS principle is resistant.

Yes you can re-enter but the dynamics of the trade have been altered.

Have tracked the threads on this board looking for the ideal - the above seemed to be the best compromise .......?

Would welcome comment.

 

[tech/a]

tech,

whats your view about not setting your stop in an obvious place? does it really matter?

Michael as well please

(maybe you guys didnt see this post from a few days ago)

Sorry just saw it.

Thats a good question. In shorter term trades this is more important than longerterm.
I can set a stop and justify it in many places.Support/Consolidation a recient low in any timeframe.
The stop is purely for me in shorter term trading my minimisation of risk.
I want a trade going my way as soon as I get on.
I set a stop in the most obvious position and use (Generally) EOD charts to see if the stop is too far away (as an obvious stop) I do pass up many possible trades due to to wide a stop. I used to do smaller position sizes and see how they go but now pass them by completely.---some go others dont.

Trailing stops for short term trades - this is my conundrum at the moment as I have recently had two trades with good open profits, stopped out at a much lower price. What methods do forum members use to protect their profits on short term trades? Thanks Michael for starting this thread.

My view.

If a stock has moved 30%+ in a day OR 50% + in a few days and your on it then have a tight trailing stop.I like the previous days high if a gap open and the

If a stock is moving slower then use an exit such as Old Support.
Trailing stops should be used only for very fast moving spikes,to maximise profits.
Chances are you'll never get the timing perfect.Never lament what could have been,make the decision to the best of your ability and DO IT!

Then next trade do exactly the same---every now and again--Perfect!

Perhaps you can give me an example of how a trade went for you?
A chart would help.

Here is one of mine which may help explain what I do.

 

[MichaelD]

In previous posts, I outlined the reasons you should trade with a stop and the basic functions of stops at various points during a trade.

In the next few posts, I'll discuss several common methodologies for setting stops.

We'll start with a stop based on Average True Range (ATR). I'll admit to some bias first. I use an ATR stop exclusively for my long term trend trading and think it is the best of the long term stops.

You don't really need to know the fine details of how ATR is calculated, but if you want the nitty gritty, Investopedia describes it well here; http://www.investopedia.com/terms/a/atr.asp. The key point of the ATR is that it takes into account the volatility of an individual stock, so for very volatile stocks an ATR-based stop is further away than it is for less volatile stocks. The nett result is that you are less likely to be whipsawed out of a position than if you used a more arbitrary stop method, such as a fixed % stop.

ATR stops have 2 variables;
1. The time period over which the ATR is calculated. Commonly, they are calculated over 10 or 14 periods. I don't have an opinion on which is better so long as you are consistent.
2. The ATR multiplier. How many times you multiply the ATR to get your stop. Many trading books advocate using a 2.5 - 3.5 ATR stop for trend trading, but based on backtesting this is too close a stop. To really capture long term trends which run for years requires a wide stop, more of the order of 6.5 - 7.5 ATR.

Calculating an ATR stop is a bit tricky. Whilst ATR is native to MetaStock, a trailing stop based on it isn't. I am aware of 3 ways of coding this sort of stop;

1. Using this formula (taken from the TradeSim manual, but also readily available on the 'net if you search for it);

Period:=10; { ATR period }
ARC:=3.0; { Average range constant-note this is set to 3xATR whereas I recommend higher}
Stop:=C-ARC*ATR(Period);
BandLong:=If(L<=PREV, { is stop reached?}
Stop, { yes: restart plot }
If(Stop>PREV, { no: if new stop>prev stop?}
Stop, { yes: plot new higher stop }
PREV) { no: plot previous stop}
);
BandLong;

2. Purchasing TradeSim. TradeSim contains an add-on formula for quickly calculating and displaying an ATR stop which is invaluable for backtesting. (The above function is quite slow to use for backtesting purposes).

3. Using a plug in indicator developed by Richard Dale which can be downloaded from here; http://www.tradernexus.com/advancedstop/advancedstop.html. It's free and it's fair dinkum.

Following on from this, I'll post 3 charts along with commentary on how the ATR stop works.

 

[MichaelD]

Example 1: KZL. A 6.5 ATR stop would have kept you in this uptrend since June 2006 and would not yet have signalled an exit despite the recent price volatility.

 

[MichaelD]

Example 2: CER. This is a great example of a whipsaw, where the 6.5 ATR stop was hit and then the price immediately reversed. This can and will always happen with any form of trailing stop, no matter how you set it. There is nothing stopping you from re-entering such a position if you get another entry signal, but the whole point of rigidly following a stop will be shown in the next chart.

 

[MichaelD]

Example 3: BCL. Here is a classic example of how a trailing stop will save your capital from oblivion. The trailing stop was hit at 5.00 and the share price just kept on going south. if you hadn't exited, you would have wiped out the vast majority of the capital in this trade (the last traded price was 0.335).