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October 13, 2012

How to add stop loss orders to a trading system.

Stop loss represent maybe the most difficult task a trader must think about before trading. I think only ten percent or less of all the trading books dedicate at least a couple of pages to it. But stop loss, especially with leverage trading is crucial.
I will share now as much as possible. It took me I think nearly five years to understand the real importance and the right way to size it.
I’m a basicly a mean reverting trader, sometimes trend following. I read once about mental stop loss. It’s like you think where to put it, and when the price come you execute manually the order. I think this is crazy. When the price will come you will have I think about one hundred new good reason to be in trade, also if losing in the meantime, and you won’t execute the order.

1 So definitely use a physical stop loss.

I remember a couple of time that i found myself removing physically the stop because it was ‘too tight’.
It ended in a tragedy. I lost months of gains in a couple of hours. Simply terrible… When the stop loss is in, it’s there!

2 Not a fixed based stop loss, but a volatility adjusted one.

I use Wilder’s Average True Range to calculate it. So it the market requires a bigger stop it’s not a problem.
(I will share the details with my e-mail list) (be patient i’ll do it)

3 Stop need to respect redditivity rule (See Michael Harris’s work)
(I will share the details with my e-mail list) (be patient i’ll do it)

4 Stop loss order must be integrated with position sizing algo, money management system, position counting, recovery system (from drawdawn), leverage algo (how to choose leverage)
(I will share the details with my e-mail list) (be patient i’ll do it)

I’m not writing everything here because this is the essence of my trading methodology. It took me a great amount of energy to develop, that’s why. I’ll do in a private download link. I hope I gave you some good ideas in the meantime.

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