Wednesday, 15 September 2010

Stop Losses

Poorly placed stop losses are one of the reasons that most traders lose. Correctly placed stop losses save your life and make you profitable.

Right at the beginning I have always said that I have a drop dead stop in the market to cover each and every trade but I don't use stops to exit a losing trade - I watch the trade and stop myself out through the DOM.

The problem is then, how can you back test to find your trader's profile and gain the confidence in SIM to KNOW that your methodology has the required win rate and profitability?

The answer is to use dynamic stops. In the beginning of learning to trade, we use hard stops. We don't know what we don't know and believe that if I can limit my losses then I will make money. Problem is that while this may be partly true, picking a number for a stop loss to use will be the right number probably only about 33% of the time. These average stop loss numbers, discovered by a computer, are exactly that: average. Losing trades should be exited when you know they will be a losing trade. Just picking a number based upon the entry price will give only very average results at best.

Stops, to be dynamic, should not be based on the entry price but be linked to support or resistance or other market related action. Back testing this by computer is more challenging as it requires more complex coding and an understanding of market action.So developing an exit strategy, the way you developed your entry strategy, needs to be part of a final trading plan.


  1. Hi El,

    By referring to the DOM as an exit tool, how exactly do you use it? Do you compare (cumulative) bids and asks to each other? Or do you use order flow?

    Best regards,

  2. EL,

    really helpful for me right now as I am on my way to MY final TP. Currently have some issues with where to place an optimal stop-loss on an outside-in picture I have added to my TP. Thank you!

    One of the ELers

  3. Samer, I just click the DOM to trade - no analysis value for me.