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Stop Losses are for Sissies… (2)

Stop Losses are for Sissies… (2)
Tuesday, April 24th, 2007 @ 11:43 am by Mihai Marinescu

The title of our blog discussion already prompted reaction from our traders… Paul admits that if using stops makes him a sissy then he must be so when it comes to trading. Along the same line of thought I must admit to be one too, and I believe most professional traders could also be considered “sissies”, for the same basic reason: they refuse to trade without stops…:) Don’t worry Paul, I was just trying to make a point – neither I nor any of our instructors would ever advise anyone to trade without a protective stop… However this myth circulates among traders, we have heard this phrase more than once, which is exactly why I think it is important to clarify certain points with regard to the use of stops when trading on Forex.

I mentioned from the very beginning that we are considering the “sissies” to be more sensible then the “neckbreakers”, and in what follows we will explain some of the reasons why. However, those who believe trading without stops is preferable have some arguments of their own, that I will try to expose in brief in today’s article. So, why do the “neckbreakers” prefer “walking on a tight rope without a safety net”, as Sunil put it?

First, there is a technical argument. Some trading platforms suffer technical problems from time to time, and as a result price sometimes displays huge spikes of hundreds and sometimes even thousands of pips up or down in only a few seconds. Of course, any stops at any distance in the direction of the spike will be wiped out instantaneously, and the trader will get his trade closed for no reason, while all the other platforms perform without any problem. I suppose we can all understand that such a situation could make any of us mad…

Some traders believe that not using a stop at all will protect them from such situations. If their trading balance is big enough compared to their positions in the market, they might be right, too… These spikes are essentially errors, and they are corrected in a matter of seconds, after which price goes back to its normal movement. Our traders may be right inasmuch their trades would probably not be stopped out by such rare events. However, I personally experienced this problem with all the brokers I have worked with and I can say that even if my stops were hit on such an erroneous spike, all positions were eventually rolled back and I got out of the situation with no harm or loss of any kind in my account. Once I was even credited an unrealized profit just because without the spike I might have reached the target of my trade!
Of course, these highly improbable events are still possible and your broker may not be such a nice guy, so there is a possibility that you lose something after such a problem after all… Nevertheless, this is definitely not an argument in favor of not using stops when trading, due to some very sensible reasons: 1) these events are very rare; 2) even if they happen, respectable brokers always roll back all positions after the event so no harm is done and 3) even if your stop is hit- if it was placed correctly – this will not be a catastrophe and your account will not suffer much anyhow, so there is really no reason to make such a big deal about it.

Then, there is the argument of stop hunters… I must admit I personally consider this to be a point to be taken seriously, as all of us know there are many stop loss hunters out there, and placing our stops close to the market price will give them the tools they need to fight individual traders and win the battle. Especially brokers which act as market makers can manipulate price action in such a way that stops have a high probability to be hit if they stand around certain key levels… Basically, what the neckbreakers say is that they do not want their money to go to such sharks, and they prefer to keep their stops mental.

My answer to all this is yes, I admit such things may happen, and as much as that might bother us it is not really in our power to change market mechanisms and realities that have been there for decades… However, I would like to draw attention to 2 important points: placing a stop and getting it hit by a stop hunter is definitely annoying, but we must be smart choose the smaller risk…If our stop gets hit, we will live to trade another day, however if our trade goes hundreds or thousands of pips against us there may be no tomorrow for our trading account. The market is sometimes punishing us, and this is part of the business, what is harder to accept is to end one’s career just for being proud enough not to place a protective stop. Secondly, this reality prompts us to set intelligent and technical stops on our accounts and not mere dollar-value or round-number ones… Placing a stop is one thing, HOW and WHERE we place it, well, that’s an entirely different story… And this is where education can make the difference between a successful trader and one who can only watch some charts on a demo, wondering “what if”.

Thirdly, there is the “I know what I’m doing” argument. I mean, some traders just “KNOW” the market will go up and down, and as a result they feel no need to place a stop since there is nothing to be protected against (If the market WILL go up, it can’t go down at the same time, right?). I think there is no need to comment on such a childish attitude, and of course any trader who thinks like this has no idea in what danger he is placing himself… Actually, it doesn’t even matter much if he places stops or not, unless he changes his view of the market failure will be for him just a matter of time – maybe not today, maybe not tomorrow, but eventually the market will eat him up and feed his account to the sharks.

Will be back with some more pros and cons on using protective stops…

5 Responses to “Stop Losses are for Sissies… (2)”

  1. Paul says:

    Good Points Mihai. Understanding Stops needs to be seen in the context of truly defining your risk. The How and the Where of using stops are pretty personal to the trader however they still need a consistent plan!

  2. Greg says:

    Mihai, thanks for posting your article. I had recently also written an article on the importance of risk management:

    Forex Risk Management

  3. Parmalat says:

    Actually I’m deeply against stops. Trading has nothing to do with mathematics, it’s all about emotional intelligence. So if your emotional intelligence allows you to gauge the market sentiment at a certain point in time and you also have several technical reasons for opening a position then you are sure that your technical reasons will not fall very easy, even if someone goes for your stops.
    I’ve started to make constant profits since I eliminated stops from my trading. Further more, my winning trades percentage is more than 70%, I made so many pips in the last 18 months that even my wife was pleased and I would definetly not recommend anyone to use stops unless his EQ doesn’t allow him to understand the market.
    No mathematics and no stops, only feeling and cold blood. If your technical arguments disappear you definetly have to close your position.
    For example I’ve been in the same USD/CHF short as you’ve been since 1.1800. If I used stops, the move on March the 12th would have probably taken me out. However, the market feeling was deeply in favor of the CHF and at the same time I felt it didn’t yet have the power to fall through 1.1500. So a retracement back to channel top was 100% possible without doing any damage to the shorts. Even if that retracement happened in 20 minutes – the market sentiment wasn’t changed at all and I remained short all the way, taking profit last week at 1.1200.
    Understanding the message of the market is big business! When you feel the market in the same way you feel your wife if she’s happy or upset – be very sure that your technical arguments will hold! And if they don’t hold – be very sure that the worse has already happened and close your position.

  4. mmarinescu says:

    Hahahaaa, very nice comment, thank u for that! I particularly agree on one of ur last observations: When you feel the market in the same way you feel your wife if she’s happy or upset – be very sure that your technical arguments will hold! Joke aside, you make a very good point there, the “feeling” of the market is paramount.
    Actually, since I wrote this article, things changed in many ways in my own trading. I still hold the importance of stops for educational purposes (when you teach you must be responsible and go for the “safest” advice, even though that might not be the most profitable). I mean, id rather have one of my students make half of the profit he’d make if he were not using stops but know he’s not in danger of losing the entire account 😉 But on my own account i trade 80% without stops – as i know I will have the cold blood to cut a losing trade if i know the market DID turn. What I do on my own account is not necessarily educational :))
    On the other hand, if a setup is more risky or it depends on a certain level to hold then I ALWAYS place a stop, even on a demo. Same when I enter with large lots.
    Thanks again for your comment parmalat, much appreciated!

  5. Parmalat says:

    Completely agree with you Mihai, teaching someone to trade is another hard business, and it’s better for the student to get used to taking losses automatically (by placing stops) – so that he can take them manually when required if he won’t be using stops anymore. You have a very good point!
    The Romanian school of trading is the best :)

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