Tuesday, 3 August 2010

Stop Loss Orders can be Dangerous to your Financial Wealth

Stop Loss orders placed in the market are a MUST to prevent disasters that can happen due to catastrophic news events, internet disconnection and similar things. They are NOT the tool for a discretionary trader to use to routinely exit from a losing trade unless you are a scalper.

One of the greatest causes of failure to reach CP is exiting from trades either too late or too early. If your trader profile is somewhat like mine or longer in length of time in trades then using a stop loss to exit is a cop out that could be costing you heaps.

I am a discretionary trader and I use my discretion to exit. I have a drop dead stop, way out of the way of possible price fluctuations within my trade's expectations (5.75 points for the ES, for example).

As soon as I have a trade triggered, my job is to monitor the trade at the close of each bar. The fact that I use range bars is a distinct advantage as much of the noise is eliminated and a new bar is created in line with the level of volatility.

My criteria for "stopping myself out" is not usually just price.

Support and resistance levels are not knife sharp. They are "around" a number so I need to monitor what is happening when I hit these levels. I can do this by watching the DOM, or better still, use the inside the bar information from MarketDelta to tell me what "they" are doing. Both the Volume Breakdown and Footprint info clue me in on whether I am seeing short covering and long liquidation, move in the balance within a bar from buying to selling or vice- versa. I can then make a more intelligent decision on whether to exit my position or not. Of course sometimes price just moves vertically through my level and I exit quickly due to the limits of price being exceeded. In other instances I have the opportunity to double down and make more money.

There is not much worse for me than to see traders exiting a trade because of a relatively small adverse price movement only to have to re-enter again at a more adverse price and finally having a winning trade but no profit due to the first unnecessary exit and the late re-entry. Doing your back testing and creating a proper trading plan eliminates a lot of these "bad beats" which are, in reality, self inflicted wounds.

Some of the new ELers from the training like the Euro FX (6E) and I do too.

Tomorrow I'll be starting a multi-part blog post on collecting and using trading statistics.


  1. Tom,
    Are you able to get much from MP for the Euro/6E? Still trying to figure that out as it spreads pretty thin...

  2. Its a very large Profile. It needs to be split into its distributions each day if you want to use more than its extremes and any single prints. If you toggle it and then look for the "something new" breakouts.

  3. Hi EL, what is the name of the indicator you've added recently adding the swing high/low horizontal lines? Thanks

  4. Hi Tom. Any advice on how to manage your risk once you've 'doubled-down'?

    I agree with you on the stops issue but I've wiped out a couple of sim accounts from 'scaling in' one too many times. I find it works for a few successful trades but can fill you with a mindset that suggests you cannot lose, which can obviously be pretty dangerous(i fade areas such as vwap +/- 2 sd's fyi and feel that scaling in at these areas can profitable, but i need to work on exiting the bad positions quicker).

    Is there a certain level of experience you would advocate before introducing 'doubling down' into your trading plan?

    Lastly, do you try to work your doubled position to full profit target or do you scratch the original trades on the way down (on shorts)?
    rgds, Joe

  5. Joe, I doubledown only against an area where, if exceeded, I know I am wrong and can exit without having assumed much more risk than the original trade. I exit the doubled down part back at where I triggered the original trade to take that profit in case I have to double down again and also to restore the original risk parameters.