Are Your Stops in the Right Place?

safety net

I’m going to let you into a little tip here today that will help you work out if you are placing your stops in the right place.

One of my biggest annoyances in my own trading is when I am taken out of a trade before my exit signal appears.

It makes my blood boil.

I’m a stickler for consistency. I want to know if my system makes money every year. So far it has done for the last 5 years straight. However, the moment I get out of a trade because my stop loss has been hit, I’m no longer trading my system.

My results are no longer that of my system.

And it bugs me. I hate it.

As a result I place wide stops and use smaller position sizes. I still trade with the same risk (usually 1%) but I want my stops to simply act as a safety net, there to protect me in case something goes nuts. Ideally 100% of my trades would be closed manually by me because an exit signal appeared.

How do we know our stops are in the right place?

Simple. By keeping record.

One common little tip I like to share is something I started doing a few years back. Every trade in my record now has a column for whether it was closed manually or automatically (i.e. a stop loss order).

This allows me to go back at the end of the month, quarter or year and look specifically at those trades.

The main question I want to ask myself is….

Of those trades that closed automatically due to my stop loss being activated, how many cost me money, and how many saved me money. In other words, how many went on to make good profits as per the original system, and how many stopped me from losing more money by doing its job as a safety net.

Immediately this information will tell me if my stops are too close. If they are costing me money by getting me out of trades prematurely, I need to widen them. If they never get clipped, perhaps I can afford to bring them closer.

It’s an incredibly simple approach that works wonders, adding a mechanical aspect to stop loss placement. A process and proceedure that many traders use gut feel to execute.

The problem with placing stops based on gut feel is the distinct lack of consistency as well as the impossibility of being able to measure it.

Yet most traders won’t use this simple trick because it takes some effort.

Many traders fail to keep adequate records. Many traders can’t be bothered to analyse their trades.

But if you are serious about improving your trading results, it’s as simple as adding a column to your trading record.

Start recording which trades close due to a stop. Then in 3 months time, look back at those trades and check…did the stop loss help or hinder? Did it save or lose me money?

Then make any necessary adjustments and repeat.

Within a few months you could have a perfectly optimised stop loss positioning policy for your trading system.

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