Quote from Daal:
darkhorse,
This seems to come down to the issue of whether stops can improve or hurt trading performance. I have a love hate relationship with stops, simply because I see some flaws in them.
I'm not sure the value of stops can be discussed universally, i.e. outside a specific methodological context. With some methodologies they work well; with others they don't work at all.
Sort of like discussing appropriate debt to equity ratios for a business; there is no one size fits all, it depends on the business.
Quote from Daal:
Take someone who is counting cards in a blackjack game in a casino that is not aware of it, he has an edge when he is playing, it would not make sense for him to stop playing at some point for any reason OTHER THAN
-He no longer thinks he has an edge(Got mentally tired and is having a hard time counting the cards, or something else)
-Is reaching his drawdown tolerance level
If I put a trade in and I still think I have an edge based on my analysis I would highly prefer to cut down the position but still keep it because I believe I still have an edge, the fact that the price went against me is evidence that my thesis MIGHT be wrong(I do believe the market is semi-efficient and large price discrepancies between true value and market price are rare, every time the discrepancy increases, it counts as evidence against the thesis given its rarity), which is why I would cut the position but not totally because the analysis still says there is an edge.
I can't stop playing the blackjack game simply because I got dealt a few losing hands in a row and somehow think the deck is 'cursed', I stay rational and keep betting
I would say this is not "an argument against stops" so much as an argument for why stops do not work for you.
Consider this counter-example:
A mechanical trader creates a profitable trading methodology based on intermediate term momentum swings.
In both backtesting and post-analysis of live trades, this mechanical trader discovers that, on the whole, if a position moves against him by X volatility factor or does not become profitable within X days, the odds of a follow-through signal have degraded enough that he is better off simply exiting the trade.
What this trader has done is built a profitable methodology around exploiting risk:reward scenarios on a mechanical basis. Part of what makes the system profitable is cutting down losses by immediately exiting when a signal has become degraded -- in other words, the edge is in the backtested methodology and cutting losses through stops is a part of this system.
I am not a mechanical trader; the idea is that the value-add of stops to a methodology is wholly dependent on the context of the methodology itself.
This difference is not a matter of degree vs a fundamental conviction approach; it is a different way of conceptualizing the problem entirely. Not better or worse, just different. Which goes back to the original point: It is hard to discuss the worth of stops outside methodological context.
Quote from Daal:
Now one might say 'well, what if your analysis is wrong and there is no edge'. I say this
-If the trader is a bad analyst and consistently get things wrong he is going to go broke whether he uses stops or not. With stops he MIGHT take a bit longer(Though it will depend on things like position sizing etc) but he is going to broke no matter what
This is true -- a poor approach will find a way to bleed out over time, whether fast or slow. But this is not a knock against stops per se, just a recognition that good money management cannot mitigate bad trading.
Quote from Daal:
This is why I don't scorn Rogers 'I will hold no matter what', he does take that a bit too far perhaps but I see him as the guy counting cards with an edge refusing to quit due short-term bad luck
I don't scorn Rogers either -- he has been too successful, and what he does seems to work for him.
I do cast a wary eye on "unshakeable conviction" types though -- their style could not work for me, much as my style could not work for them.
I believe too much in fallibilism; I see the world as too complex a place; I am too in touch with the question, "What if I could be wrong?"
Three examples of the Rogers mold gone bad: Bill Miller, Bruce Berkowitz and John Paulson. After a string of excellent years, those guys took their unshakeable convictions and rode them right into the dirt. Not saying all conviction traders do this -- just that it's a risk I find personally unpalatable.
Quote from Daal:
I do see situations where a stop CAN improve performance, its on the situations where the stop itself is an edge. If you know that the price going through a certain point means there is no edge left or turned the other way, this is an edge in itself and makes total sense to put a stop there. There COULD be an edge on stuff like MAE(From Tharp books) but for Macro Trading that is kinda useless since we can be trading corn one day and Thai bat the next, different MAEs would apply
Right -- saying "the stop itself is an edge" is another way of saying "the stop is an intrinsic part of a profitable methodology."
Re, Thai baht to corn etc., the easiest way to normalize risk points is as a function of price action and volatility, i.e. chart levels and average trading range.
We do this as a matter of habit with position sizing too; for us a "1.0" position size means planned risk of 50 basis points, appropriately adjusted to the volatility of whatever vehicle is being traded, which can result in very different notional exposures of one vehicle vs. another (three natural gas futures contracts might work out to the same planned risk as thirty corn futures contracts etc.).
