The problem is not the effect of stops on performance but the reality that if you cannot trade with stops you should not be trading at all. Backtests only reveal hindsight bias and get to understand that.
Our 400,000 Trade Test Proves Using Stops Is Not Very Bright
- Thread starter marketsurfer
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The problem is not the effect of stops on performance but the reality that if you cannot trade with stops you should not be trading at all. Backtests only reveal hindsight bias and get to understand that.
The group i worked with packaged and sold the research as an automated trade engine called themachineus. Peace, surf
I don't directly trade OPM. But that's a weird philosophy. So long/short funds should not exist?
I hesitate to add to this explosive discussion, but I've done some research of my own on this subject. I agree with some of the points already made, but I'd like to make a couple more.
Let's assume you're using your own stop levels that you don't disclose; rather than broker stops. I realise there are additional problems with the latter.
Theoretically a stop should be set according to the following criteria:
- correct amount of capital to bet per trade
- desired holding period
- volatility on the market
In fact the first two factors are related - the shorter your holding period, the less you should bet on each trade.
Using stops which haven't been set properly will most likely harm performance. Trailing stops "work" (i.e. add to returns) when trends occur; simply put they mean you stay . In fact even when the entry rule is random a strategy with stops will make money if underlying prices are trending. Wider stops capture long trends, shorter stops capture shorter trends.
Trend following in equity markets doesn't seem to work so well, at least for the last 20 years or so, and for shorter holding periods of say less than 6 months. It works better in equity indices and other futures.
This means that using tight stops when trading individual equities will probably harm your returns. I would imagine this is what the OP was talking about.
Indeed if markets are strongly mean reverting then what you need is a stop profit, rather than a stop loss.
Using trailing stops will change your risk even if your returns are killed. You'll get fewer large losses, and more large gains. Most people would consider this an improvement. This might even be enough of an improvement if .
It is not neccessary to use stops for risk control:
Firstly for some kinds of systems it would make no sense to do so (at least to me). If for example you are running a mean reversion system, and you get stopped out, you'd immediately want to re-enter the trade as it will look even better value. Of course you could write a rule so you don't do that; but the correct trade to hold at any time should be unrelated to what trading you've done in the recent past.
Secondly, you can do what portfolio managers do for risk control (and I do). They do not allocate a % of their capital for each bet; instead they say "what risk do I want on this position" (this will depend on conviction / forecast, overall portfolio risk target, and the allocation of risk budget to that position). They'll then set the size of their bet according to the desired risk. For example the risk of one e-mini is around $1K a day. If your risk target for the position is $15K then you buy 10 contracts. We're looking at risk over periods of time rather than for each position over the expected holding period.
Thirdly if you're running a trend following system, where you will automatically cut your position if the price reverses, then that will probably make trailing stops redundant. This is especially true if it's not a binary system, and you'll start cutting the moment the trend fades.
However stops are undeniably a very simple way to do risk control which most traders will find easier than the portfolio approach (to see what I mean by that see below).
A final minor point; stops might give a false sense of security (unless they're guaranteed by the broker, possible with some spread bets and CFD providers but at a huge cost in wider spreads), and encourage people to run too much risk.
GAT
In my view, which I am certain will be backed by a majority vote in the US, there should be a ban on high risk operations when using OPM. This is coming and you know it.
Time will tell. Dodd Frank act must have surprised you.
UNDENIABLY CORRECT
That is evidence of a terrible entry system.