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Which is better, a trailing stop or a fixed stop? Answer: Yes
The real answer is it all depends on your overall strategy. Too many traders are myopic in that they define their trading method at the trade level. Is fixed or or trailing stop better? the answer is, it depends on your overall trading strategy. For one particular instance of a trade a fixed stop might be better, for the next instance of that same trade, a trailing stop might be better. The issue is, you will never know with certainty which approach will work best with the next occurrence of that trade.
What you need to do is take your trading setup(s), and examine how it behaves across a large number of historical trades, and see whether a pattern develops that points to which approach would suit your particular trading style, approach, and setups best. Once you find that out, then trade that approach and only that approach, knowing that some trades will have been better one way, and others the other way, but overall the approach you have chosen has proven itself superior historically, and therefore should most likely continue to prove itself in the long run.
Hi Mannya, as Mike pointed out understanding the intraday volatility of each instrument in my opinion is critical in stop placement. I've attached 2 examples to illustrate. The first screenshot shows CL volatility based on 3 years worth of 30 minute daily data. It analyzes volatility between 6.30 to 7.00am, 7.00 to 7.30am, 7.30 -8.00 and 8.00 - 8.30am.
The first column is the percentile (0.50) is the median, the second column is the bar ATR, third column is the length of the up-tail, the 4th is the length of the down tail. The Delta is the market driven order flow, the Delta high is the high delta, delta low is the low delta, the M+T = the Move column + Tail + and then the ATR. So for oil between 6.30am and 7.00 am (if the bar finishes higher) the median move is $0.30 cents, the tail up is 0.20, down 0.1, median delta is 802, delta high is 1224 and low (210) and an average true range of 0.71. Now if you look down the different times of the day you can see the ATR is not materially different.
In other words the intraday volatility from 6.30 am to 8.30am for oil is on average 0.60 to 0.71 cents for each half hour period. So if your typical trade typically lasts 30 minutes then this type of analysis is important as it provides a good yardstick for stop analysis. In this example if you enter a trade at 7.00am and are using a fixed stop of 30 cents and hold your trade typically 30 minutes then the probability of a stop-out is significant. What is also very helpful is comparing the current delta with the median delta to determine ATR range extension. This is a whole different discussion topic though.
Now the second screenshot shows the TF. This is a different beast and needs to be traded differently than CL. The first point worth noting is the 30 minute ATR from 6.30am to 8.30 am has a little more variation (although I don't have first half hour of pit open for oil). Having said that, using the ATR as a percentage of price oil is a bigger mover. At 6.30 to 7.00 am on the TF the ATR is 5.8 points , 7.00 - 7.30 is 4.7 points, 3.9 points and 3.2 points. So dependent on when you enter the trade the historical volatility provides a good yardstick for setting stop placement. Now based on my analysis of market conditions I will keep the stop the same but vary the target up or down using the historical ATR as my starting point.
In fact for each 30 minutes and for each instrument the system automatically draws an ATR proxy bar using this data. Now if I'm trading a short term time frame (which is becoming less and less) seeing a significant hidden divergence on the order flow, start seeing successively high ticks of 600-1000+ on the NYSE tick showing evidence of buy programs, start seeing my competitors trapped and evidence of them aggressively covering their positions (in other words smart money realizing they have become dumb money) then I will adjust the ATR range to increase my target and risk reward. In fact I've started to get quite aggressive with these setups and doubling my position. Actually this is one of my favorite trades on the TF and NQ.
The other point to note is the median delta for oil for a bar close higher is 802, 705, 742 and 793 which shows very little variation. In other words market driven order flow for CL is pretty constant across the time periods for an up bar. Now if you look at TF, the median deltas are 831, 675, 423, 423 respectively showing a significantly reduced delta as the day progresses. This is where you can bring in the upper percentile deltas. This is separate topic though.
"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."
That is like saying: "Which is better red or blue?" There are different tools for different set-ups. It depends on what your comfortable with. I depends if you want to be in control of the exit. It depends on how much room you put in your trailing stop. The most important thing is just that you are using a stop.
"I have two basic rules about winning in trading as well as in life: (1) If you don't bet you can't win. (2) if you lose all your chips, you can't bet."
--- Larry Hite from Market Wizards by Jack D. Schwager
I use only stop loss but I think that a combination of both could be a nice choice. For example: the trailing stop could be fixed, in a long position, below the stop loss; this will allow the trailing stop to do its job after a certain target will be reached.
Its a complicated topic. But I found that a stop that chase the market down when you are short helps in locking up your profits and also protect you from reversal ( you lose less). However, You have to have the right stop to start with. fore Example, Crude oil the best stop value is 20 ticks...just my thoughts
IMHO, stops should not be used to maximise profit. I've watched traders use all manner of crazy stop strategies, such as adding more breathing space when the market goes against them, to mental stops, and even a combination of the two! Their psychology, IMHO, risks bankruptcy and hospitalisation.
My current view is that the trader needs to calculate their stops before deciding to enter a trade. Measure market volatility, and use that to determine the amount breathing room that the trade needs. Use that stop distance to calculate your risk/reward before deciding to place your bid/ask. Discipline yourself to prevent the market punishing you.
