For each trade how to you make a decision on stop size?
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How do you set your stoploss?
- Thread starter Indie Cator
- Start date
First of all, I choose my stops based on current or previous market action, and not on my entry price. My reasoning is that the market doesn't know or react to the where I entered my trade, but it does react to where previous support/resistance is and what current price behaviour is. Equally I don't see why you should set a stop based purely on the % of your capital at risk - that way the stop is determined by what position size you took on, which makes no sense at all, as the market has no idea how big or small you are trading!
I always want my stop to be at a price where, if it is reached, it is a highly likely that I am wrong. I want to avoid placing a stop at a point where, if reached, the market is more likely to be just gunning stops or undergoing a normal retracement.
That usually generates two types of stop. The first is placed a "significant" amount away from the market i.e. further than a normal retracement, and not just beyond an obvious support/resistance level where it could be taken out by stops being gunned.
You can calculate what constitutes a larger than normal retracement by looking at the average true range (the difference between the day's high and low, also called ATR) per time period for the last X time periods (e.g. ATR for the last 25 days). If the market moves a larger and larger multiple of that range (i.e. 2x, 3x, 4x etc), then the move becomes more and more signficant. Whereas if it moves equal or less than that range, it is just normal market noise and does not give you a meaningful signal.
You can calculate support/resistance using the usual methods - look at previous meangingful highs and lows, places where the market stalled and reversed. Look at the widely-followed moving average levels (e.g. 50 day MA, 200 day MA). Look at typical retracement levels (e.g. 50% pullbacks). If the market has retraced a fair bit and reached one of these levels, it is very common to see it take them out by a bit, trigger stops, and then reverse. So you need to avoid placing your stops too near to these levels. E.g. you could place your stop 1 x ATR or more beyond the level. Or you can look at how far "stop-gunning" typically takes the market beyond support/resistance zones, and then place your stop somewhat further away than that.
So I would basically determine stop size by where the nearest support/resistance is, but add in an extra bit of leeway. Then I would take a position size such that the stop getting hit would lose me an acceptably small % of my capital. The advantage of this is that if your stop gets hit, you can be highly confident that you are wrong, and that exiting is the right thing to do. The disadvantage is that you give back quite a bit of profit if you have an open trade from your last entry signal.
To minimise this problem, I look to place very close stops once I see the reasons for my trade fading away. E.g. if I entered because of a breakout through a price level on strong momentum & volume, then the market reached a signficant support/resistance level, and momentum slowed, and then began to reverse, I would place a very close stop as a retracement is much more likely than normal. Or longer-term, if I entered a market because it was in a long-term bull market which was not widely appreciated (e.g. negative sentiment vs strong price action), then I might place a close stop if sentiment starts to become wildly positive whilst the market on the other hand starts acting weak.
Thinking about where your stop should go, based on the market's key technical levels, also gives you a good idea of when to enter and exit. For example, if the market has moved a long way in your favour, such that the nearest logical stop is now a long way away, but the nearest potential price barrier is much closer, then your risk is greater than normal, and it would make sense to exit on signs of momentum fading and reversing.
On the entry side, whenever you see a situation where a well-placed stop is not too far away from the market, and a reasonable price target (e.g. the next support/resistance if the market reverses) is significantly further away, then you can enter with a pretty good profit/loss ratio (i.e. you might make 3 times what you risk). Wait for momentum to turn, then enter the trade.
I always want my stop to be at a price where, if it is reached, it is a highly likely that I am wrong. I want to avoid placing a stop at a point where, if reached, the market is more likely to be just gunning stops or undergoing a normal retracement.
That usually generates two types of stop. The first is placed a "significant" amount away from the market i.e. further than a normal retracement, and not just beyond an obvious support/resistance level where it could be taken out by stops being gunned.
You can calculate what constitutes a larger than normal retracement by looking at the average true range (the difference between the day's high and low, also called ATR) per time period for the last X time periods (e.g. ATR for the last 25 days). If the market moves a larger and larger multiple of that range (i.e. 2x, 3x, 4x etc), then the move becomes more and more signficant. Whereas if it moves equal or less than that range, it is just normal market noise and does not give you a meaningful signal.
You can calculate support/resistance using the usual methods - look at previous meangingful highs and lows, places where the market stalled and reversed. Look at the widely-followed moving average levels (e.g. 50 day MA, 200 day MA). Look at typical retracement levels (e.g. 50% pullbacks). If the market has retraced a fair bit and reached one of these levels, it is very common to see it take them out by a bit, trigger stops, and then reverse. So you need to avoid placing your stops too near to these levels. E.g. you could place your stop 1 x ATR or more beyond the level. Or you can look at how far "stop-gunning" typically takes the market beyond support/resistance zones, and then place your stop somewhat further away than that.
So I would basically determine stop size by where the nearest support/resistance is, but add in an extra bit of leeway. Then I would take a position size such that the stop getting hit would lose me an acceptably small % of my capital. The advantage of this is that if your stop gets hit, you can be highly confident that you are wrong, and that exiting is the right thing to do. The disadvantage is that you give back quite a bit of profit if you have an open trade from your last entry signal.
To minimise this problem, I look to place very close stops once I see the reasons for my trade fading away. E.g. if I entered because of a breakout through a price level on strong momentum & volume, then the market reached a signficant support/resistance level, and momentum slowed, and then began to reverse, I would place a very close stop as a retracement is much more likely than normal. Or longer-term, if I entered a market because it was in a long-term bull market which was not widely appreciated (e.g. negative sentiment vs strong price action), then I might place a close stop if sentiment starts to become wildly positive whilst the market on the other hand starts acting weak.
Thinking about where your stop should go, based on the market's key technical levels, also gives you a good idea of when to enter and exit. For example, if the market has moved a long way in your favour, such that the nearest logical stop is now a long way away, but the nearest potential price barrier is much closer, then your risk is greater than normal, and it would make sense to exit on signs of momentum fading and reversing.
On the entry side, whenever you see a situation where a well-placed stop is not too far away from the market, and a reasonable price target (e.g. the next support/resistance if the market reverses) is significantly further away, then you can enter with a pretty good profit/loss ratio (i.e. you might make 3 times what you risk). Wait for momentum to turn, then enter the trade.
...backtesting
Quote from Lobster:
Me neither. It really depends on the market you are trading whether stops make sense at all. If you trade options in the US you will most likely hedge rather than place stops.
Yes the market determines stops. I only trade short term equities and futures indexes as an amateur so I am not broadly based.
Stops, price bars and volume are like a dynamic tripod for me.
Further, I only trade in one manner in each market, so I have no variation in how I protect my trades with stops. I do not use stops as direct parts of trades.
The longer response here, above, seems related to infrequent trades, so perhaps my comments can fill in the territory for short term and intraday trades.
For equities, I rank the % per day each potential buy is demonstrating in the last five profit cycles. 3 to 6 % a day is common. As I look at these five cycles I also look at bar ends that extend beyond the trading activity. I conclude the stock will continue as before. I average five bar extensions out of short trends and also five extensions at peaks and troughs. I add all extensions and move decimal point, actually. This value is twice the expected irregular price action that might come along. So I just draw the trend line of my stock's performance after entry and offset it with a second line by the value I have calculated. this is my offset stop calculator for the whole trend I will take profits on. Then I switch the daily chart to a 30 minute chart and monitor it. I change the stop twice a day come hell or high water. This drives the stop up continually and the trend I am in has to beat it. When the trend maxes I sell. The stop is never used. This occurs over 3 to 8 days at this time. I do about 30% a month with capital.
For intraday indexes, it is more active. Market pace is primary as the guide. I list all formation price values that define the formations on the 5 min chart. This is a log of values. Minute by minute values occur as a trend proceeds. As a trend begins to end, no more values appear. I judge trends as fast, medium and slow. I keep my current stop "back" from the last entry on my log a certain distance. For slow it is loose at 4 back, for medium it is back three and for fast paced trends it is tight at two back.
This is strange I know. But I pay attention and I am usually in the market making money. I do not exit on stops.
I C&R periodically. The stop value that is circled as being the best one is the value I use. Having a schedule of times to change a stop is very basic. When I am not adding potential stops to the log, something is up for sure. It is then that I use my other signals to analyze stuff. I decide and act, then. This takes profits and begins my next trade. My only job is to stay on the right side of the trade at all times.
In ES, the pace changes from slow money velocities to fairly high ones. They are there most of the time. The stop log is a very good way to estimate the rate of profit taking at anytime.
Footnote: For trading on the opposite side of being whipsawed in congestion and consolidation or when a high volatility stall is in play or when news is coming up at a predetermined time, I always run my stops at twice the contract level that I am trading. This is simply to be able to insure picking off the beginning of the next trend which emerges from the end of what is going on. It is a reversal type trading situation. I usually also have an ability to inject a market trade in the same direction of my reversal stop to supercede it if a hit occurs in the market. Hits represent high profit potential periods.
It never matters what comes up, just being on the right side of it and being in the markets is what is important. Stops are the front line of guaranteeing you are ready.