Two Stops For Your Trading System?

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We are constantly told to use stops by trading gurus and I have to hold my hand up and admit that I too have told you and other readers to use stops. In fact I have said “you must use stops, no questions” before.

It seems that when people are creating trading systems they assume stops are hindrance rather than something worthwhile . Stops provide two purposes. One to protect capital from an unforeseen events and secondly, to control risk within the trading system so that it returns a profit at the end of a basket of trades.

Whilst most systems use only one stop there is nothing stopping (ha ha!) you from using two. Countless times I have seen/traded methods where you wait for a signal at the end the bar/candle before closing a trade. Not a bad way to trade but quite often when you enquire about stops for these systems you are told, “you don’t need one-the indicator is quite fast so you get a ‘close order’ within 5-10pts anyway”.

This is fine as far as making a profit goes. If that works on paper that is great, so sure you can use that as your exit method and stop. However, it fails to address what happens with in the signal bar before it closes. Quite often across all markets there is a spike in price or an extra impulse in a reversal. So it is quite possible that your acceptable 5-10 loss on a trade could easily double to 20pts on one of these candles. These price moves are nothing to worry about in the bigger scheme of things but what happens if the moves was 40pts? or more?

You have to protect your capital from all types of impulses in price. So would it be better to have a stop for 20pts or to wait for the bar to close for a lose of 40pts? This doesn’t even address big new events that we don’t know about in advance or have forgotten about.

What size should this stop be? It is up to you but you don’t want to make it too big so that it takes weeks to come back from such an event. I would suggest you make it a factor of your average trade win size. So at least you will know that if there is an unexpected even you have protected your capital and you know how many winning trades it will take on average to get you back to where you were. You want to make sure you leave yourself enough capital to trade in the same way you were before.

So if you were trading 3 contracts before you don’t want to be left with only being able to trade 1. As this will make it vastly harder to get back in profit.

I still advocate using one stop i.e a system stop that you put in at the being of the trade that will trigger intra-bar/candle that is factored into the expected risk to reward ratio of that system. This way you don’t need to worry about a capital protection stop.

But either way, you need something to protect you.

2 Responses

  1. Suntrust Online Banking says:

    I would suggest you make it a factor of your average trade win size.

  2. Louie says:

    I always trade with stops. I think to trade without doing so is capital suicide.

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