Cutting losses short should be subjective

L

lbradman

This is my real post but I really need some help after having loss so much in the past 2 weeks from this highly volatile market. I only just started trading CFDs and have a system which I've backtested nmpteen times with confidence but ever since starting my trading adventure on the 9th of last month I've made around 30 odd trades and have made losses of over $6000 in the past 3 weeks. As you can imagine I am absolutely gutted and disgusted. And the thing that hurts most of all is I followed the rules of the system cutting all my losses as soon as my maximum loss level was reached but as soon as I close the position reverses and goes in my way. As a result what I want to ask is this :
If your in a position and it makes a large downwards move tomorrow whether it is straight gap down from the open or over the course of the day then this will stop you out. But if you did all your analysis right and the stock is from a good entry(eg in uptrend on pullback volume etc etc) AND there is NO negative news on the company then I believe you should stick with the trade and NOT CLOSE it rather wait it out next day or two to see if you can atleast get a better price to exit from or even have the trade turn positive. Because if the large downday spike is unusual for the recent price history then treat as such - a market overreaction or correction whatever you may call it. Hence it does not mean you should immediately sell at your stops because that should only be the case when the price "GRADUALLY" drops over a few days not one large massive drop from a panic selling day. What I mean by gradually is its falling within the normal price range (ATR if you will) for the stock. If the large spike down was because of some bad news around the company then for sure get the hell out sooner as it will get worse but if nothing fundamentally has changed with the company then dont let the fear of turning a loss turn into a bigger loss grip you because stastically it favours a turnaround and what your experiencing right now is really just a correction which will eventually come back to its original levels.

I know one of the cardinal sins of trading if not the biggest is to let your losses grow by not cutting your losses short. Well I'm at the point where I'd say stuff that as its only a subjective rule you should follow based on the stock and market conditions because if you follow that blindly then you'll experience what I've been through ..absolute massacre from the markets as its see- sawed its way to squeeze my shorts one day to turn around and dead cat bounce my longs then turn around again to squeeze my shorts before going back the other way after I'm out at my stop loss.
I do strongly believe you should cut your losses but I dont think you should follow it rigidly because if the stock behaves uncharacteristically by dropping so much and nothing is wrong with the setup and company is still good then its wrong to sell as the move was overreaction and should just let it pass as its bound to go back higher.
Tell me if anyone has felt like wanting to break the rules for this because had I held onto my positions for atleast another day risking a loss from $250 to $1000 I would have seen a dramatically reversal to be in a profitable position.

Thanks and feedback appreciated.
 
" Hence it does not mean you should immediately sell at your stops "

so mental stops are being moved, isn't that a major rule being broken? price action is telling you that you should get out, no?
 
if you have 3 + positions would you ask the same question?
if you have 1 position you should enter real stops
 
Quote from lbradman:


Tell me if anyone has felt like wanting to break the rules for this because had I held onto my positions for atleast another day risking a loss from $250 to $1000 I would have seen a dramatically reversal to be in a profitable position.

Thanks and feedback appreciated.
More...

There are many exit strategies, and many types of stops.

If you have confidence in your entries, then try another approach.

Try a time stop. Number of bars, days, etc. Exit at open, close, etc.

The value I find in a time stop is that it helps to take emotions out of the trade. Obviously your exit strategy has not been able to do that for you...so try something else.
 
"I do strongly believe you should cut your losses but I dont think you should follow it rigidly because if the stock behaves uncharacteristically by dropping so much and nothing is wrong with the setup and company is still good then its wrong to sell as the move was overreaction and should just let it pass as its bound to go back higher.
Tell me if anyone has felt like wanting to break the rules for this because had I held onto my positions for atleast another day risking a loss from $250 to $1000 I would have seen a dramatically reversal to be in a profitable position. "

Thanks and feedback appreciated. [/B][/QUOTE]
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Yes, I could very much relate to your scenario given your hypothetical explanation (ie the "company is still good", tell that to the Enron/MCI/Worldcom investors) although you would never really know if nothing about the company's fundamentals have changed (as I suspect insider trading is more rampant than what is being reported/investigated). That being said, everyone must have a MAXIMUM tolerance for stop loss NO MATTER what the circumstances are as one of the first conecepts of trading that must be accepted is that ANYTHING CAN HAPPEN. I usually use a $ stop so if my blotter shows a certain $ amount loss I usually close the position without regard to whether it is a top or bottom. Reason being is that my MAXIMUM THRESHOLD tolerance is risked that it does not pay to hold the position any longer (basically once a certain $ stop is reached it does not matter how much I believe the probabilty of the trade will return to my favor, it simply means I miscalculated the magnitude of the range and therefore the price I must pay for is cutting at that peak or bottom).

One of the ways I deal with this situation especially knowing the markets will be volatile is to reduce size. I feel proper position sizing is one of the biggest elements that determines a trader's success or failure. Many times traders bite more than they can chew (basically they miscalculate the magnitude of a trend and get stopped out).

To illustrate my point, if you trade typically 1000 shares and the market is extremely volatile, a 10 penny fluctuation is quite "normal" (this assumes you trade stocks that typically have 1 penny spreads). Now that would normally cost you .10 x1000=$100. If your stop loss is say $100 then you would be forced to cut and panic. However, if you trade at 100 share lots, you would only get hit with .10x100=$10. That being said, you would be able to tolerate a volatility of as much as $1 before you would be forced to cut and exit the trade. I believe my point is that your stop loss should not be arbitrary because you can come up with a million self justifications (oh, the MM/specialist is out to get me or this is a short squeeze etc.) but rather you must adjust your position size according to the market's volatility. I feel many traders lack this flexible trait to adjust their position size according to the market's volatility. As mark douglas put it, "we must learn to think in probabilities as we never know for sure" (how do we know that it is just a short squeeze and the markets will revert to the mean and therefore we should not cut at the top/bottom).

The very interesting point you said was "the move was an overreaction and should just let it pass as its bound to go back higher." But the truth is that we do not really know for certain it was an over reaction and is bound to go back higher/lower as trading is NEVER 100% sure (we can only say that 90% sure the stock will go back up/down but when we hit our maximum risk tolerance it won't matter anymore as this is our circuit breaker to avoid blowout days. I've read articles where some traders were so consistent for several years,some 5 years to be exact, only to lose everything in a few weeks. I think this shows the extreme importance of discipline where you cannot negotiate with yourself. I always like to illustrate the point that if anyone was ever 100% sure something would happen in the markets they would be a millionaire/billionaire instantly (my simple logic is that even if you were only 100% sure a stock would move 1 penny in your favor then you could greatly profit from it by buying a billion/trillion shares for that quick 1 penny profit, obviously this is pure hypothetical and would never be possible but it does go to show you that nobody is ever that sure of themselves).

Just my thoughts on your comments as I could greatly relate to your situation (i'm always trying to figure out the optimal stop loss as I do not like to have the "death by a thousand cuts" adage happen to me). In fact my motto is take your profits quick and cut your losses slow (this is following the logic that stocks RARELY go straight up or down and they rarely go against me immediately from the get go. Besides, by cutting your losses slow, you increase your chance of turning those losses into profits or at least minimizing cutting at the bottom and at the same time if you take your profits quick you never allow a winner turn into a loser). I believe following your rules will lead to efficient and consistent trading results. JMHO
 
Thanks to all for your feedback.

Firstly I started using hard stops but got stung really bad when the price gapped down on open below the stop level and because the stock was quite illiquid it resulted in a loss of 4R half of this from slippage! Only after I got filled did the price slowly rise back up to a more safer level. Had I just waited after the initial hour of trading where prices are most volatile I would have been able to exit at a more comfortable price. Hence the reason why I NEVER leave a stop order in the market prior to open and only use a MENTAL stop. I believe if it gaps past your stop on open then you should wait after 30 minutes and see theres a chance it would try and fade the gap hence getting you out better. If not then close it but in most of my backtesting it pays to wait after the 30 minutes. The way I manage the mental stops is to set alerts so even if I have multiple positions I can take action immediately an alert fires.

Quote from lindq:

There are many exit strategies, and many types of stops.

If you have confidence in your entries, then try another approach.

Try a time stop. Number of bars, days, etc. Exit at open, close, etc.

The value I find in a time stop is that it helps to take emotions out of the trade. Obviously your exit strategy has not been able to do that for you...so try something else.
More...

Thanks lindq I can see your point in using timing stops to remove the emotions out and I have backtested many ideas and exiting on open seems to give the best since my system is based on swing trading over 1-3 days. I like the idea of waiting a number of bars first so I'll test that idea.

To zdgreg I'm trading CFDs on stocks and looking at indexes soon from Australia.

Thanks nugundam you've given me a lot of thinking to do especially as you never really do know for sure what the market is capable of no matter how many times you look in hindsight at your stopped trades to see them go back in the good. I've clearly demonstrated I get too emotional in my trades and because of a bad string of losses I'm already willing to break my exit rules in an otherwise good system.

I think I did the right things ie forcing myself to get stopped out at my maximum risk but the thing is as its very volatile period we are under I definitely should either drop my risk level and consequentally my position size OR to SIT ON THE SIDES. I've chosen to do the latter as I'm still licking my wounds from my unpleasant start to trading and I'm sure most traders would be inclined to do the same during this time. Just on your point about taking your profits quick and cutting your losses slow can you clarify what you mean by this. I'm trying to get better profit exits seeing its a short term hold but how do you decide to close a winning position quicker than later without breaking the let your profits run rule. And what do you mean about cutting losses slow? Shouldnt you close as soon as your stop level is hit?

Thanks to all the feedback.
 
Gaps are just a cost of the game and something you should allow for in developing your strategy.

Use stop limits (big limit gap though) if thats the issue. Not having a stop in the market is a recipe for disaster in a learning trader (and many who consider themselves experienced).

It sounds like you have made the right decision.
 
Quote from lbradman:

Firstly I started using hard stops but got stung really bad when the price gapped down on open below the stop level and because the stock was quite illiquid it resulted in a loss of 4R half of this from slippage!
More...

Illiquid stocks are a different beast than liquid ones. So maybe stick to liquid ones or change the way you handle stops on illiquid ones. Stops on illiquid stocks are a great way to lose money quickly.
 
"Just on your point about taking your profits quick and cutting your losses slow can you clarify what you mean by this. I'm trying to get better profit exits seeing its a short term hold but how do you decide to close a winning position quicker than later without breaking the let your profits run rule. And what do you mean about cutting losses slow? Shouldnt you close as soon as your stop level is hit?"
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Well, my point may not be applicable to you as you mentioned you are a swing trader and you have slippage issues (something that I do not have to deal with as I'm with a prop. firm that offers the most competitive rates in the industry). Basically with my firm, all things being equal, the more trades you do, the more profits you make (i'm not sure if you've heard of rebates/credits but this reduces the slippage in trading and in fact is a negative transaction cost that allows you to buy and sell at the same price and still profit from the trade).

Given my current situation above I would be considered a scalper and therefore i generally do NOT let my profits run (contrary to the general trading rule). I tend to do high probability trading (again, something that most traditional traders would disagree with as they say 30% of your trading should be winners but they should make up more than the 70% of losers). With my current strategy, I say cut losses slow because I've noticed that if a stock goes against me say 3 or 4 pennies, there is a high probability that it will go back to say minus 1 or 2 pennies. So as opposed to cutting at 3 or 4 I would cut at minus 1 or 2 thereby reducing my losses. I find it rare that a stock will go straight 10 pennies against me so I do not "strictly" cut at 3 or 4 pennies. Meanwhile the opposite is true. If I enter a position and it immediately goes 3 or 4 pennies in my direction I ALMOST ALWAYS take my profit. As you can see when you have negative transaction costs this could prove to be a very profitable strategy as I am always "booking" profits (I'd rather take profits quickly than wait for that "home-run" as there is too much uncertainty, afterall most people would agree that to predict a 20 penny point move is harder than to predict a 3-4 penny move). Another way of looking at it is that I basically trade the "noise" (again, something that most traders would consider insane because of their cost structure, it would not allow them to do this and they would need to make money in trending markets, something that only occurs 20% of the time they say.).

Earlier in your message i noticed you mentioned something about R multiple and couldn't help but think of a recent book I read by Van Tharpe that talks about expectancy theory and opportunities. I can't remember the title right now of the book but it was very interesting how the author made several comparisions about different styles of trading. One type had a great risk/reward ratio while the other one did not have such a great risk/reward ratio yet in the end the latter was more profitable (i believe it was the market maker's edge because it had such a high turnover). It basically taught me the concept of trading in opportunities. Yes, you may have the best risk/reward ratio but if you only have 1 opportunity a month to optimize that trade, then it probably won't amount to much when you compare it with another strategy that has a fairly low risk/reward ratio but has 500 opportunities in a given day.

To illustrate say you have the best trade where you only risk 1 penny yet you make 200 pennies. This might be the ultimate in risk/reward as it would be considered to be a 200R trade. However if you only make that once a month on 100 shares that would amount to $200. Now what if you have a poor risk/reward trade where you risk 4 pennies and you only take 2 pennies (as opposed to risking 1 and taking 200). At first it might seem like a losing proposition but what if I told you the probability of getting those 2 pennies while risking 4 pennies was 75%? In the end if you do the math you might end up with a positive expectancy of say $0.20. Now $0.20 might not mean much when compared to the $200 trade but when you do that 100 times in a day that amounts to $20. Now you multiply that by 20 trading days and you come up with $400. So in the end the low risk/reward trade is better off because there are more "opportunities" to make money. This in my opinion is how most MMs and Specialists make money. They take a lot of small profits and occasionally, when a major news event comes out, they might take a big hit but in the long run they are profitable (again, with reference to Van Tharp's book, he talks about building a snow wall as high as possible and ensuring the wall does not collapse by only taking small black snowball hits and avoiding the big boulder snowballs that destroy the wall completely).

Anyways hope I clarified some of your questions and my ideas presented are just my opinion. Again, someone who does swing trading should be better able to give you advice on how to deal with the issues you've presented.
 
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