Today’s Lesson: Honing your stop placement.
Stops are mandatory orders for risk management. The big question is where to place them. Before we explore different methods, understand that per-trade risk is controlled as much by your position size as your stop placement. Wide stop = less quantity (shares, contracts). Tight stop = more quantity.
Using a fixed percentage formula solves the sizing question. Assuming your account is $10,000, your percentage risk per trade is 2%, your max loss is $200. Now divide that by the stop width and you have position size. Easy enough.
Here is a sample of some popular stop loss placement methods:
There are many more methods. The question is which one to use? The only way to be confident in your choice is to examine hundreds, even thousands of prior trades. You need statistical relevance. Small sample is worthless.
Document historical trades based on several methods. Keep track of the Maximum Adverse Excursion (MAE, the distance the trade went against you but didn’t stop out). You’ll have a data set that will allow you to fine tune the stop placement.
Here’s an example from our Volume Profile strategy what your analysis can tell you. From a sample size of 9384 trades in all market conditions: Stops = 3283 or 35% of the time (average stop 3.50 points). MAE on the remaining trades averages 1.50 points. These metrics were the best using a stop of 3 ticks beyond the volume level.
The numbers for you will vary based on your strategy entry/exit rules. Do the homework and find stops you can be confident in.
P.S. Join us every Saturday morning @ 10:00 ET for our weekly LookBack (5) trade review session. Every trade for the week is analyzed. Now open to the public. Meet the team. Ask questions. Register here.