Welcome aboard. I guess I will get this slow ball rolling with some ideas I have on stops. I was thinking this through the other day and wrote up a few lines.....
"I sit here and contemplate the possible perpetuation of a fraudulent idea.
It is the idea that you must trade with stops. Well, not that completely, because I do believe stops are very important, but it is the proper use of stops that I believe is not taught. In fact, most of the time the use of stops is taught as a risk reward type of analysis. If you are willing to risk 4 points, to gain at least 4 points you must be correct more than 50% of the time to breakeven. Well, that all sounds good….but consider that many of the times you are wrong, by 4 points, the market stops you out and continues in the direction you thought it would go. Of course, the answer always is you can get back in.
However, you have two things working against you now. Number one you just lost four points. This is psychological damage. Will you get back in? What will have to occur for you to get back in? Most of the time a move back through your original entry price. Very few traders have the mental makeup and discipline to immediately re-evaluate the market and re-enter a position after being stopped. This creates problem number 2. You are down four points on a trade that is going the way you thought it would and now you re-enter it. Even if you gain four points, you are now only breakeven on the day.
How many times does the market chop around? Take a look sometime. How often do you call the exact top or bottom of a move? Rarely. In fact, I am willing to bet, without study that at least 75% of the trades one makes, sees their entry price again after going against them. Most of us are smart enough to know direction, but might not get the exact entry timing down.
So what does this tell us. We cannot use dollar based stops. We must use larger market based stops and have the discipline to exit a trade prior to them being hit if we see that we are mistaken in our read.
Too many traders, I believe are being eaten alive by small 2 to 5 points stops, when they could simply go to a market relational stop (usually 8 to 10 points) and improve their performance just by changing their stops.
Using a 10 point stop that has a 20% chance of being hit is like using a 2 point stop on each trade. However, using a 4 point stop that history shows has a 60% chance of being hit is really using a 2.4 point stop on every trade. That is a considerable difference over the course of a couple of hundred trades. In fact, the difference is 40 points. In the course of a year this could easily cost 100 points to the account. For a small account, that is simply unacceptable.
Each trader must evaluate their stops against their record to determine if they are being set to tight. My belief is that when that analysis is done, the answer to winning in this game is not setting tighter stops, but larger stops. Tighter stops simply ensure more losses."
-SE
News 
Market Data 
Discover 
