Trading Risk Management – Adjusted Stop Loss
Here is an excerpt from an email conversation I recently had with another trader, in which he talks about using tight stops:
“I took this approach early on but was stopped out so many times by the market that I started to widen them. Too many times the market pulled back on my stops only to find out that it kept doing what I thought it would. trade. However, I admit that the financial risk is greater. But expecting the market to move quickly each time in the desired direction is asking too much.”
This is a common observation. There is nothing more frustrating than being stopped and then watching the operation move towards its objective without you.
There is really no right or wrong answer regarding stop placement, just what makes you money and what doesn’t. So if wider stops provide a greater advantage to your trading, then that is absolutely the right thing for you to do.
However, for me, wider stops just don’t fit my trading style, risk tolerance, or psychology.
In any case, I thought it might be beneficial for some traders to hear a bit about what tight stops mean to me.
I believe that regardless of whether a trader uses a tight stop or a wide stop, it should be in exactly the same place.
Having a tight stop does not mean finding an entry and then placing a stop loss at a small fixed distance and hoping it is not hit. Regardless of whether a trader’s intention is to trade a narrow or wide stop, the stop loss should be placed in a position that overrides the setup.
If my stop is hit, it means something has changed in the market or my setup is invalid. Either way, it shouldn’t be in the trade.
So for me, the stop should be in the same place, regardless of how big my risk is. That place is where I have evidence that my setup no longer provides an advantage in the marketplace.
The low risk (tight stop) does NOT come from placing the stop close to the entry, but from placing the entry close to the stop.
For example, if I intend to go LONG on a retracement to a support area, my stop loss will be below the swing low that forms at support. So, I’ll try to get in as close to that support as possible. This is how I get tight stops.
In a way, this is the opposite of most traders. They will find an entry and then calculate the stop loss position. I will be different in that I know where the stop is and then I will calculate the input. And if I can’t get an entry that allows a small enough risk, I’ll just pass that trade.
Oh, and another important point: the lower risk also comes from incorporating a time stop. If the operation doesn’t work out for me in a reasonable amount of time, I’m leaving. I recommend reviewing your trades and getting an understanding of how quickly your setups should become profitable. Then if that period of time passes and you’re still stuck in the vicinity of the input, or on a drawdown, then perhaps your setup has lost its advantage. Maybe it’s time to step aside and look for the next opportunity in the markets.
happy trading,
lance beg
(c) Copyright 2008. Lance Beggs. All rights reserved.
