I came across this article on our sister trading articles site and thought it was worth re-printing here. Although it is about stock trading I thought it might spark a debate in day traders and forex traders alike. Have a read.
Are Stops Really Necessary in Stock Trading?
Are Stops Really Necessary in Stock Trading?
There is a lot of nonsense written about trading, but one of the more amusing things I have read is about the importance of “loving your stops”. Of course what the writer was trying to convey is the importance of protecting your stock market positions from large losses by employing some kind of stock trading stop loss.
However, let me say at the outset that I do not love my stops. In fact I hate my stops and only use them when absolutely necessary. The problem is that stop losses do just that, they stop you from losing additional money. The problem is that nobody wants to lose money and so most people will tend to make their stops too shallow and the result is they never lose a whole lot of money on any given trade, but almost all their trades go to losses and so in the long run they still lose a lot of money.
Although I am not recommending you trade this way you need to understand that under utopian trading conditions you can make far more money without using stops than you can with using stops. Just about any kind of market entry will eventually go to a profit if the position is never exited with a stop loss.
I have always known this but the point was recently driven home in a very practical way when I had to adapt the trading system I post on my web site to accommodate government regulations concerning “day trading”. The regulation that I am referring to is the trading account requirements for “pattern day traders”. This regulation requires that any person engaging in “pattern day trading”, that is entering and exiting a position on the same day, must have in excess of $25,000 in his or her trading account.
I do not day trade, but sometimes I take a position, intending to keep it for two or three days, and it starts to go south almost immediately. And to avoid a major financial hemorrhage of my account I exit the trade on day of entry. But according to these bizarre government rules when I get out of that trade, on day of entry, in order to save my butt, I am engaging in “pattern day trading”. And if my account has less than $25,000 in it at the end of the day, the account must be closed.
So in order to avoid this situation for both me and my customers I redesigned the system I trade on my website to trade essentially without stops on day of entry. I was surprised to find how easy this was. What I found is that the overall performance of the system was improved. What I also found was that trading many markets (diversification) was actually better protection against aberrant price moves than was the placement of a stop loss. If you are in 20 markets and you get killed in just one you might still have a good profitable day because of the price movement in the other 19 markets.
I have been trading now without stop losses on day of entry for nearly eight months and have had no problems. I might add that I also traded through the “Flash Crash” of May 6, 2010 and emerged from that fatal day without mortal injuries. Our overall losses for May in fact were very small compared to the large profits we had made the previous five months.
I have posted every one of the trades I have taken since December 1, 2009 and there is not a singe trade that I have exited on the same day I entered it. Go ahead and examine those trades and you will see the results of trading without stops on day of entry. There are really no large losses that stand out, we certainly win more than we lose, and our bottom line shows large profits approaching 100% annual returns on our investment.
I trade 96 markets and on a really busy day I might be holding 30 to 40 positions. In my view this is far better protection than stops. I think that all this talk about loving your stops comes from stock index traders who almost always lose money anyway. Stops just make their losses a little more tolerable and allow them to indulge in their gambling habit a little longer. Believe me, I have done a lot of stock index trading in my 20 years of trading and I know of what I speak. Stock index trading is a game of the big boys running the stops of small traders with weak hands. If you do not have the money to allow you to use very deep stops you should stay away from the stock index game.
I do not think much of stock index trading and do not think it has anything to do with the kind of short term stock investing that we do. Most of the stock index traders I have known are kind of thrill seekers who seem predisposed to losing money. I have never known either a day trader or a stock index trader who really consistently made money over a long period of time.
Contrast this with our trading approach that never ties up a high percentage of our money in any one market and consistently yields high returns year after year in all kinds of market environments.
In summery, I believe the importance of stops has been overdone and you will make more money if you do not have to use them. What will save you money more than price stops is spreading your money out across many markets and limiting your time in trades to two or three days. And furthermore make sure you limit losing trades to only TWO days.
What I am really saying is that TIME STOPS offer you more protection than do PRICE STOPS. You should try stock trading without price stops. Believe me you can live without stock trading stop loss. I think you will find that the dangers of trading without price stops have been vastly exaggerated.
About the Author
Occupation: Stock Trader
Robert Buran, StockBrain99 on Twitter, is the author of “How I Quit My Job and Turned $6,000 Into a Half Million Trading”. He has traded small accounts and traded millions of dollars. Bob trades live on the Internet and is into low risk with high yields. His website, Short Term Stock Trading, posts his 2-day and 3-day real time stock trades several times daily and is of great interest to day traders and short term stock traders.