Welcome back to the land of Zulu.I was doing some thinking about stop values and wondering if its smart to use a stop value of 180 pips. Where did I came up with this number and is it the right value to use?
After all, stops are mandatory in currency trading because losses are inevitable. You have to have a good way to cut losses when things don't go your way.
One way to look at it is % of your account. $180 is 1.8% of a $10,000 account which seems a bit high. I've read that professional traders risk no more than 0.5% (one half of 1%) of their account on any single trade.
Another way to look at it is percent of the underlying. GBP/USD closed the week at 158.41 which if my math is correct is 15,841 pips in total value. 180 pips is 0.011% (slightly more than 1%) of the underlying. That means it would take just over a 1% move to shake me out.
Would I ever trade stocks on a 1% stop loss value? I'm not a day trader, but I would never consider using a stop that tight when trading stocks. Otherwise you are prey to the market makers and the slightest wiggle will shake you out.
Its even worse in current trading where the FCM's can see your stops. Any stop value less than 100 pips is likely to get hit. I've seen where a pair will trend in one direction, then suddenly have a 30-pip tick in the other direction, and go right back to where it was before. The FCM's will eat you alive on a stop any tighter than 100 pips. This is especially true outside of active market hours.
William O'Neil of Investors Business Daily regularly preaches at 8% hard stop-loss value for stocks. I find that that is too tight for stocks and frequently let positions go 10% or more before cutting my losses. I'm not sure how well that applies to currencies since currencies are unlikely to move 10% in one day like stocks do all the time.
Yet another way to look at it (and probably the smartest) is to look at the Average True Range of the pair.To find this, bring up http://www.dailyfx.com/charts/. Bring up GBP/USD and go to the daily chart, then add the Average True Range indicator with the lookback of 14 bars. Now select View, Information and you will get the view on the left.
PS - Tried to to this with http://www.bestfreecharts.com and they didn't have enough precision to see beyond 2 decimal places. They are not used to dealing with small numbers you see in currencies.
Anyway, you'll notice (graph all the way at the top) that the range has been declining for the better part of the year. Back in Feb of 2009, the daily range for GBP/USD was over 400 pips. As of now, its about 175 pips. This means that on average, the difference between the high and low is about 175 pips per day.
I'm thinking the stop should be greater than the average daily range, possible between 120% to 150% of the average true range. So for GBP 1.2 times the ATR is just over 200 pips. So with my stop at 180 pips, i'm not too far off the mark.
Finally, the relationship between stops and % wins is a key factor. The table on the left shows, for a 180 pip stop and several AverageWin values, what is the required percent Win Rate rate to do better than breakeven. Good providers on Zulutrade have a better than 80% win rate. So according to the table on the left for an 83% win rate, the average win has to be about 30 pips or you can expect to loose money with a 180-pip stop.That would explain why i'm not making money using providers like Pro-B5 whose average win is about 12 pips. Contrast that with Coolie 1997 who averages about 26 pips per win and an 86% win rate.
I don't want to disparage Pro-B5, because he's a really stand-up guy, but his trading style is like picking up nickels in front of a steamroller, you'll make some profits for sure, but sooner or later you will get steamrolled. Pro-B5 has made some changes lately and i'll do an update on him soon and review his recent performance.
Anyway, that's enough for now, i'll post results from my demo accounts over the weekend. Enjoy the rest of your Friday.
That is a pretty cool calculation. It is always helpful to know at what point a stop loss will be needed to make money with a signal provider. I would almost venture to say it is the most critical point as gains can vary, but you don't want your max loss to vary. I have probably mentioned this a few times but when you download a signal providers history on zulutrade you can sort on max draw down column. You can then pinpoint a stop loss you are considering using and delete any trades from the data that are at, or larger in draw down. You take the amount of trades you deleted and multiply it by your stop loss (This number is your losses at that stop loss if you had started trading with this provider from the start). The rest of the trades you total up the gains. If the gains outweigh the total you added up in stop losses then you may make money with the signal provider. (This of course is assuming you are in on all trades, so you need to factor that in. Signal providers that open a bunch of trades at the same time make it impossible to calculate this way). On coolie1997 I put my stop off at -105 pips based on my evaluation of his history. He has had 5 trades that went past -100 pips. Two of those came back for a loss less than -100 and the other three pretty much took the max on the loss. If I multiply -105 x 5 I get -525 in losses. Totaling up the gains after removing the 5 losing trades at my stop loss give me 3,038.
ReplyDeleteI am hoping people can see why you and I make a effort to discuss this critical point of setting up your stop loss. The ratio here is almost 6 to 1 in gains to losses for coolie1997. The results are showing similar in my live account as well.
At any rate good post on this topic Tcxmon.
JT-
ReplyDeleteThanks for the thoughtful response. It brings up a few good points:
- It make good sense to review the detailed history of the provider and convert all the losses above your stop into the max stop for your account.
- Once you have that subtract the total profits shown by the provider to a multiple of his/her losses capped by your stop value
- Finally it exposes the difficuly introduced by the fact that providers may open more lots that our accounts are setup to handle.
This last item is a pain point since there's no easy way to sort this out without doing some annoying date arithmetic.
But most important again is the stop value. The providers pay little attention to stops because the have complete visibility to their own trading methods.
The subscribers (on the other hand) have little visibility into the trading method, therefore have no other defense other than a stop value.
Thanks for the quality comments and keep up the fine quality blogging over at:
http://zulutrade-top.blogspot.com/
Cheers,
http://zulumon.blogspot.com
Hi all!
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