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Tight Stops can give false comfort
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Tight Stops can give false comfort

  #1 (permalink)
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Tight Stops can give false comfort

Never use a tight stop because it gives you comfort that you are some how protecting your capital. I am not saying tight stops cannot be used. But better know how they effect your draw down and expectancy. A tight stop can cause larger draw downs and reduce the expectancy of your system in a significant way.

As traders we cannot think on an individual trade basis we have to think on an overall system basis over multiple trades.

For example I have seen some say I have a 1 to 3 risk reward ratio. But what they are measuring is on a trade by trade basis. Stop at 1 target at 3 for example purposes. That 1 to 3 risk reward ratio per trade may not give you that same risk to reward on multiple trades on an overall system. I do look at the ratio on a single trade basis but it is lightly weighted compared to risk to reward on overall system.

Point being if you are using a tight stop because it gives you comfort it may be a false comfort. I have heard many people say I use tight stop because it makes me more comfortable. You may not be protecting your capital at all and may draw down more than if you use a wider stop. Going with what gives you comfort instead of what stats say on overall system can ultimately lead to a very uncomfortable position.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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  #3 (permalink)
Fortitudo et Honor
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I also think that systems that employ "1:3 risk/reward" tend to focus heavily on entry efficiency and edge. To expand on what you're saying...if your edge encounters a bad patch in the market, then your tight stops can result in a serious drawdown on your equity curve.

I'm finding it's better to focus on exit efficiency and taking what the trade will give me, which places less emphasis on how accurately I timed my entry.

I think entry efficiency has much more volitility and variance than focusing on exit management, which if done properly, is more timeless and consistent.

In essence, if your strategy focuses on exits, rather than entries, during bad patches, you'll simply make less profits, rather than see an increase in the number of losses (and drawdown).

I'm not really sure it's accurate to focus on R:R on a trade basis, unless you have a completely rigid system setup.

My R:R is calculated over the entire sample set, as my profit targets vary, depending on what the market is doing. On one trade, the outcome might be 1:1 (i.e. I risked the same amount of drawdown as the profit) but on another trade, it might be 1:5. Only in the wash does an overall R:R ratio play out and only in hindsight really....I try to limit my losses, but the upside can vary significantly.

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I agree completely!

It is more expensive to get stopped out on 5 5-tick stops than one 20-tick stop, but some people have a hard time getting that.

It depends on the instrument, though. I usually only need a stop of 6 ticks on the ES, but often use 15 on CL. There is a lot of "random" noise, and it would be stupid to get stopped out by it...

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You often see people using small stops, say 5 or 10 ticks, and then when the stop gets hit they get right back in the market in the same direction.

This is because their stop made zero sense from a market point of view. It was just a static stop to make them feel good. This kind of stop is worthless.

Your stop should be placed whereby when price trades at that level, you agree that you were wrong about the trade. You certainly have no desire or intention to get right back in at this same level. In fact, quite often you may want to reverse at this level.

You should always consider your risk management prior to placing a trade. If the necessary stop is 100 ticks, but your risk management maximum is 50 ticks, then you cannot take the trade.

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Not to be a conspiracy theorist, but I'm convinced after watching oil now all this time, that there's manipulation and traps that ocurr.

If you have a small/tight stop, it's very easy to get "stop hunted" right out of your position, only to watch it go back your way.

With higher stops and room to breathe, I think you become less of a victim of the traps and ploys of the larger firms....maybe not for all instruments, but definitely on something like CL.

If you're trading tight stops on CL, you'd better be ****ed sure you got the entry right.

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Lornz View Post
I agree completely!

It is more expensive to get stopped out on 5 5-tick stops than one 20-tick stop, but some people have a hard time getting that.

It depends on the instrument, though. I usually only need a stop of 6 ticks on the ES, but often use 15 on CL. There is a lot of "random" noise, and it would be stupid to get stopped out by it...

I agree market does have a big effect on where stops are placed. When I developed a system for CL it completely changed my paradigm on stop placement. I had to go much wider than I was on TF. Really was a lesson in comfort zone vs what numbers actually say on my overall system. But flip side is I was able to go with wider targets as well.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."

Last edited by liquidcci; August 3rd, 2011 at 12:33 PM.
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liquidcci View Post
I agree market does have a big effect on where stops are placed. When I developed a system for CL it completely changed my paradigm on stop placement. I had to go much wider than I was on TF. Really was a lesson in comfort zone vs what numbers actually say on my overall system. But flip side is I was able to go with wider targets well.

Exactly! That's the appeal of trading oil, though. It sure can move....

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Lornz View Post
Exactly! That's the appeal of trading oil, though. It sure can move....

I must admit I have a romance with CL. Speed and range crazy though as I have around 60 to 70 tick range between my stop and target yet rarely in a trade over 10 to 20 minutes. Perfect day trade instrument.

"The day I became a winning trader was the day it became boring. Daily losses no longer bother me and daily wins no longer excited me. Took years of pain and busting a few accounts before finally got my mind right. I survived the darkness within and now just chillax and let my black box do the work."
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This is a very good subject to talk about. It is what separates traders.

A Trader has a predefined setup that has a certain probability of success. A Trader has done their due diligence to backtest and record all occurrences of that setup and the success rate. A trader should have a good idea of the expected reward for this setup if he/she is truly a trader. Let me go against most peoples beliefs and fears. I do not think a trader who has done all their homework on a setup and the potential reward for that particular setup should even use a stop loss that is close to the entry price. I think a stop loss should be set at a level that is equal to 2-3% of your account balance. I do not think a stop loss below a swing low or above a swing high by two or three ticks should be used. A trader should use the critical system stop as a means to protect their capital, a tight stop is not a way to protect capital.

I think a stop loss is used more for people who have not done their due diligence and are unsure of the probability of success and the potential reward.

For an example a trade setup appears that has a 60% success rate and a potential reward of 24 Ticks at $10 a tick, most people teach that without a risk reward of 1:3 then the trade should not be taken. So an 8 Tick stop loss would be acceptable. But if this particular market has an Average Daily Range of 160 Ticks, then an 8 Tick stop loss is only 5% of the Average Daily Range. This is to small of a stop loss for any setup.

Also the time frame being used is also taken into the equation. If someone is using a small time frame or tick count if you are using tick based charts, then the setups are going to be more frequent and also the whipsaws will be more frequent.

Try using a conditional exit method for trading and you should see your success rate and account balance increase. What I mean by this is, first you must do the hard part and find the setup and the probability rate and potential reward. At this point when a trade is entered after ALL criteria for the setup are met. I propose that a trade not be taken unless a stop loss of at least 2% and no more than 3% of your account balance and at least 25% of the Average Daily Range of a market is achievable. At this point we are not going to wait for our critical stop loss to be touched to take us out of a trade. We will use a condition to exit the trade, and that also means that we will not use a profit target of a few ticks or a prior swing high/low or Fibonacci extension and so on and so forth. We will let the condition be our exit for profit or loss.

Example if I enter a trade of a breakout of a narrow range of the last 7 bars high. The stop loss may be that if it closes below the narrow range low with INCREASED VOLUME. I have seen more times than not a one or two tick below a low, with no volume behind it and then price turn around and go up 26 Ticks. At this point when it is moving up in favor of our trade we will not exit the trade with any of our shares or contracts until the exit condition is met, at this point when the trade is in the money we need obviously a different exit condition than the low of the narrow range bars. That is something for a trader to work out for themselves and their trading system that compliments THEIR personalities strengths and weaknesses.

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