Trading Without Stop

If you do not use stops, you are setting yourself up for failure. When trading
stocks, for example, if you do not use stops and hang on to losing trades to
a point where you emotionally feel you cannot exit the trade because the
loss is so large, you are doomed.

If this happens, you are “married” to that stock and it may not be a
stock you really want to own as an investment. Some stocks we trade are

good for short-term trades only because we are taking advantage of the
momentum in the stock. It may be a stock we would never invest in and
hold for a long time.

If you find yourself wishing for a stock to turn around, you’re not trading
well. Based on the reasons you entered the trade and the location of
your stop, you should always know in a second whether you should be in
or out of a trade.

WHAT HAPPENS WHEN YOU DON’T HAVE A
STOP-LOSS EXIT STRATEGY?
Never trade without knowing exactly where you will get out if the trade
goes against you. All large losses start as small, manageable losses. Let
me share with you an e-mail I received from a trader visiting the Traders
Coach.com web site. It illustrates the importance of using stops:
Dear Bennett,
I received your e-mail and I think your techniques along with your
software are fantastic. Unfortunately for me I am stuck in a bad
trade where I was caught without a stop/loss in the March “BP” several
weeks ago. I have lost so badly that I think I may have to fold
up my trading tent and seek a job! I have been waiting for a reversal
but I do not think one will materialize by expiration. I see a potential
triple top forming but I do not know how long the funds will press the
upside. I am looking for scalp trades in other markets with the little
margin I have left so as to try and recoup something by expiration.
If I am fortunate enough to survive, I will try to not make the same
mistake again.

I often receive calls from traders who either did not set a stop-loss or
failed to get out of their trade when their stop was hit. They tell me that
now they cannot get out because their loss would be too large to bear. If
this is happening to you, then you do not yet have the trader’s mind-set.
You have to realize that being stopped out is a natural part of trading. You
must accept this and not let it get you angry or upset.
Remember, it is better to cut your losses short. It is the only way you
will be in a position to let your winners ride.

SETTING MENTAL STOPS
For some markets it is better not to put the stop actually in the market
when you have the position on. Some market makers will see your stop,

and if there are enough other traders with similar stops, the market makers
may try and hit your stop. Then they make money and you do not. In
markets like this, you can set a mental stop and get out immediately if it is
hit. Be sure you have the psychological toughness to get out when you are
supposed to. If you don’t, then go ahead and enter the stop when you take
the trade.

MOVING STOPS
Never move your stop for emotional reasons, especially when it is your
initial stop. As new trailing stops are determined to lock in profit, you can
move your stops based on newly confirmed Pyramid Trading Points and/or
ART Reversals. If you add on to your winning trade (increase your trade
size), your stop must be adjusted to control your risk in relation to your
new trade size.

When adjusting your stop due to an increase in trade size, always adjust
the stop closer to your current position to lower the risk in relation to your
larger trade size. Once you do this, you should never roll back your stop,
since now your larger trade size will warrant the tighter stop to maintain
proper risk control.

Many students ask about moving stops based on different time frames.
This is an advanced technique. As a general rule, always set your stops on
the same time frame as you entered the trade. In other words, if you use a
daily chart to base your trade entry, use the daily chart to set your initial stop.

There are exceptions to this, but only after you have developed enough
experience. Become profitable using the same time frame first, then perhaps
venture into multiple time frames later.

With the ART system, stops are set based on the realities of the market
and should only be moved when the ART software designates new stoploss exits.
Read More: Trading Without Stop

7 Basic Stops

A stop-loss exit, or a stop, is a predetermined exit point you will select
prior to entering the market. Designing an effective stop-loss approach will
be crucial to increasing your profit potential.

If your trade or investment goes against you, a stop-loss approach enables
you to cut your losses quickly so that you have capital with which
to reenter the market. The alternative to using an effective stop-loss strategy
is to sustain severe and devastating losses at one point or another. The
market is unforgiving in this regard, and ignoring the inevitable is to tempt
fate and invite painful financial loss into your portfolio or trading account.

Following are seven of the most common stop approaches:
1. Initial stop. This stop is set at the beginning of your trade and entered
as you enter the market. The initial stop is also used to calculate your
position size. It is the largest loss you will take in the current trade.
2. Trailing stop. This stop develops as the market develops. This stop
enables you to lock in profit as the market moves in your favor.
3. Resistance stop. This stop is a form of trailing stop used in trends. It is
placed just under countertrend pullbacks in a trend
4. Three-bar trailing stop. This stop is used in a trend if the market seems
to be losing momentum and you anticipate a reversal in trend.

5. One-bar trailing stop. This stop is used when prices have reached your
profit target zone or when you have a breakaway market and want to
lock in profits, usually after three to five price bars moving strongly in
your favor.
6. Trend line stop. A trend line is placed under the lows in an uptrend
or on top of the high in a downtrend. You want to get out when prices
close on the other side of the trend line.
7. Regression channel stop. Very similar to a regular trend line, the regression
channel forms a nice channel between the highs and lows of
the trend and usually represents the width of the trend channel. Stops
are placed outside the low of the channel on uptrends and outside the
high of the channel in downtrends. Prices should close outside the
channel for the stop to be taken.

Other stops used are generally a form of one of the above stops or a
derivative of them. Setting stops will require judgment by you, the trader.
Judgment is based on experience and the type of trader you are. You will
set your stops based on your psychology and comfort level. If you find you
are getting stopped out too frequently or if you seem to be getting out of
trends too early, then chances are you are trading from a fearful mindset.
Try and let go of your fear and place stops at reasonable places in the
market.

Position your stops in relation to market price activity, and don’t pick
an arbitrary place to set your stop. Many traders incorrectly buy and sell
the same number of shares each time they trade. Then they choose a stop
so their loss is the same dollar amount each time they are stopped out.
By doing this, they are disregarding the meaningful market support and
resistance areas where stops should be set.

Remember, the ART software does an excellent job of identifying stop
signals, which are identified by choosing key levels of support and resistance.
This enables you to set stops that are in alignment with current market
dynamics.
Read More: 7 Basic Stops

Stop-Loss Orders and Margin

We need to cover volatility before we talk about risk management.
Volatility is the rate of the change in price over a specific
period. The faster price rises or falls through time, the higher
the volatility is. Volatility is calculated as the standard deviation
of the percentage change in the daily price. Simply put,
the faster a market moves in one direction, the more volatile it
becomes and the more likely we are to see above-average price
movement relative to previous price behavior. Another way to
say this is that the higher the volatility in a market is, the more
money a trader will have to risk per trade.

One way traders can limit their risk is by using stop-loss
orders. What’s important for traders and investors to know
about stop-loss orders is that although they work most of the
time, there is no guarantee they will be filled at your price or,
in forex markets, filled at all. There are times when markets can

gap higher or lower, particularly on the Sunday opening, leaving
a stop order filled at a different price or not filled at all.
Because of this possibility, it is best to monitor your account at
all times when you are in the market.

In our trading accounts we always look to risk no more than
2 percent per trade or 6 percent per day of our risk capital. If we
are sizing up a setup or trade and determine that the risk is outside
our parameters, we do not take the trade. Before we cover
risk, though, we need to understand the dangers of margin.
In commodity futures you often can control 100 percent of a
commodity by putting down 3 to 7 percent of the cost of the
physical commodity. An example is gold. In a commodity
account you can buy 33 ounces of gold or one mini gold contract,
worth approximately $29,700, for $1,100 down. The margin
for gold thus is 27 to 1: $1,100(27) $29,700. The danger in
this is that if you bought a mini gold contract in a $5,000 account
and gold moved lower by $35 per ounce—as it did on August
11, 2008—and you did not have a stop order placed, you would
have lost over $1,100, or 22 percent of your account, in one day.

Margin is always a dangerous proposition for untried traders,
but when combined with volatility it is treacherous.
In futures we have mini contracts, yet with the surge in
volatility in commodity prices over the last several years, many
smaller account holders have been priced out of the market as
they have been forced to risk higher percentages of their
account balances. In forex the margins are even higher, and that
makes it more treacherous for novice traders. Margin in forex
can range from 50 to 1 all the way up to 400 to 1. However,
aside from the standard contract, which has a $100,000 face
value and can be controlled with $2,000 down at 50 to 1 or with

$1,000 at 100 to 1, there is also a $10,000 contract that can be
controlled for $100 at 100 to 1 and a $1,000 contract that can be
controlled with $10 down at 100 to 1. Because of these smaller
contract sizes, it is easier to stay within the 2 percent stop-loss
rule whether you are trading a $10,000 account or a $1,000
account. It is important to remember, however, that whatever
the margin rate is, if you are wrong on a trade, you will lose
the full percentage value loss of that instrument; that means
that if you go long a standard 100,000 EURUSD contract and
the euro drops 2 percent that day against the U.S. currency, you
will have lost $2,000.

When we are short-term trading, or day trading, we generally
don’t plan on leaving the screen while we are in a trade. We
try to go with multiple contracts that give us the freedom to take
a portion of our position off at a profit that is based on market
structure and short-term behavior, letting us to allow the balance
to run on the basis of longer-term market behavior. If we are
trading longer-term time-frames, or end-of-day—using a daily
chart—we will trade at least one contract. Before taking a trade,
we figure out what 2 percent of our risk capital is (0.02 multiplied
by the net liquid value of combined futures and forex
accounts), and this is the amount we can risk per trade. Along
with giving you your stop-loss, or the amount risked on the
trade, this amount will help determine your lot size.

For example, let’s say your risk capital accounts are $10,000,
and so you may risk 0.02(10,000) $200. We may know from
experience that our risk per trade on the British pound is
approximately 30 pips per contract, or $30 per mini contract.
Thus, if we can risk $200 on a day trade in GBPUSD, we divide
$30 into $200 and get 6.66. We round down to 6, which means

we can trade six minis, or a $60,000 block of GBPUSD, and we
must put a 30-pip stop on that trade once it has been entered.
Therefore, if we sell six minis at 198.00 on a day trade, we need
to place a buy stop at 198.30. If that distance seems too short
and thus unreasonable in light of the volatility in the market
and the structure on the chart, we pass on the trade or put on
fewer contracts. If we choose to take a position trade for
a longer-term period, we can sell two at 198.00 and place a
90-pip stop or a buy stop at 198.90 to keep the possible loss at
2 percent; similarly, we can sell one short GBPUSD at 198.00
and place a buy stop up at 199.80, or 180 pips above the short
position, to maintain a 2 percent loss.

Getting back to the six-lot day trade, by risking just 2 percent
in GBPUSD, we would be able to take at least two more trades
in other pairs. Alternatively, we could choose to risk 1 percent, or
$100, that is, three mini contracts, or a $30,000 block in GBPUSD
and have the freedom to trade up to five more pairs, keeping the
total risk per day to approximately 6 percent of the risk capital.

This way we have room to day trade several positions or position
trade several pairs and keep our total exposure to 6 percent.
If there is an adverse move against our positions, we adjust our
stops and risk accordingly, always maintaining a total exposure
of just 6 percent on all open positions. If our account draws
down, so does our exposure on future trades. As the account
grows, we’re able to increase our trading size. By placing the
physical stop we learn discipline and also are assured of maintaining
a reasonable risk-reward ratio by professional standards
if something unforeseen happens in our lives or in the marketplace.
Always remember to check to see if you have any active
working stop orders when you exit your trading platform.
Source: Mastering the Currency Market: Forex Strategies for High and Low Volatility Markets

Managing Risk: Always Set a Stop-Loss Exit

Setting stop-loss exits is the first step in managing your risk. There are
a multitude of other techniques, but the first line of defense for you
will be to learn how to set effective stops and then to learn how to
adhere to those stops.

THE NEED FOR MONEY MANAGEMENT
Please understand the risks in trading the financial markets and live in full
awareness. Let your positive beliefs lead you to take the actions necessary
to succeed.

For traders to blindly enter the markets and trade simply because they
are thinking positive thoughts is to ignore the full spectrum of what is possible.
However, to live in constant fear of losing will cause you to trade the
financial markets with fear, anxiety, negativity, and aggression, which are
equally destructive.

Instead, acknowledge both sides of the coin, the good and the bad.
React to market activity with full awareness and pay close attention to
your risk control. Then you will create a positive reality with a feeling of
abundance and goodwill. By acknowledging the good and the bad—the
reality—and by fine-tuning your money management system, you are on
your way to greater prosperity.


Money management is a rather in-depth topic and I recommend that you use A
Trader’s Money Management System: How To Ensure Profit And Avoid The risk
Of Ruin (John Wiley & Sons, 2008), a book I wrote to cover this topic in depth.

It will enable you to manage your risk in every way from learning how to refine
your stops, to record keeping and analysis with The Trader’s AssistantTM, to
understanding the risk-of-ruin tables and how to determine what is the right
amount of capital to risk on each and every trade. You will probably get the
best price on Amazon.com and I urge you to continue in your quest for money
management tools since that is where you will be able to further increase your
profits.

ACCEPTING RISK
Before you can effectively accept risk in your finances, you must first completely
believe that there is a true benefit to you in doing so. This inner
belief very often comes after having experienced the power of the markets
in the form of a painful and substantial monetary loss. Regardless of how
you ultimately develop the motivation to manage your risk, it is imperative
that you do so.

There are six primary types of risk you need to accept:
1. Trade risk is the “calculated” risk you take on each trade. With ART,
your risk will never be more than 2 percent on any given trade. You will
maintain this 2 percent risk by adjusting your trade size and setting a
stop-loss exit. Advanced traders, see “Important Note” on page 78.
2. Market risk is the inherent risk of being in the market. This type of
risk involves the entire gamut of risk possible when in the markets.
Market risk can exceed trade risk. For this reason, ART traders never
actively trade more than 10 percent of their net worth. Market risk encompasses
catastrophic world events and crashes that paralyze markets.
Events causing market “gaps” in price against your trade position
is an example of market risk.
3. Margin risk involves risk where you can lose more than the dollar
amount in your margined trading account. You would then owe your
brokerage firm money if your trade goes against you.
4. Liquidity Risk. If there are no buyers when you want to sell, you will
experience the inconvenience of liquidity risk. In addition to the inconvenience,
this type of risk can be costly when the price is going straight

down to zero and you are not able to get out, much like the experience
of Enron shareholders in the year 2001.
5. Overnight Risk for day traders, presents a concern in that what can
happen overnight when the markets are closed, and can dramatically
impact the value of their position. There is the potential to have a “Gap
Open” at the opening bell, when the price is miles away from where it
closed the day before.
6. Volatility Risk can present a bumpy market that may tend to stop you
out of trades repeatedly creating significant draw down. This occurs
when your stop-loss exits are not in alignment with the market and are
not able to breathe with current price fluctuations.

Risk is inevitable in the markets and there is an art to managing the
possibilities. It is not a matter of fearing the risk; instead, focus on playing
the “what if” scenario so that you can adequately prepare yourself for any
outcome.
Read More: Managing Risk: Always Set a Stop-Loss Exit