How to use money management stops effectively
Stops are enormously important part of a traders arsenal of trading tools. Some traders confirm that stops are the most important part of their trading armour.
So here are three ways to use stops to protect your capital and lock in profits from a trade. These three money management techniques can be used in stock, futures and forex trading.
The important rule is that you do use a real stop in the marketplace. A friend of mine joked with me that that he had never seen a “mental stop” filled electronically or in the pits.
If the market is good your stop will not be hit. If the market is bad or changing direction then you’ll want to be out of it anyway. That is why stops are so crucial to trading success.
Here are the three most commonly used types of stops. Which one do you use?
(1) Dollar stop.
(2) Percentage stop.
(3) Chart stop.
If you chose (1) you’d be correct, but, you would also be correct if you had chosen 2 or 3. All three are money management stops and are used to either lock in profits or protect capital.
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1) A dollar stop, is when you set a predetermined dollar amount to a trade. Let’s say you want to risk $500 on a grain trade or $750 on a stock trade. Once you get your fill back from your broker or electronically online you simply figure from your fill price where to put your stop.
Pros: Easy to implement and use.
Cons: Can place stops too close in a volatile market
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2) Percentage stop, is a very simple way for you to place a stop on a position. Here’s how it works. Let’s say your trading account is 100,000 dollars and let’s say you only want to risk 1% of your total portfolio on any one trade. You simply take a $1,000 risk which represents 1% of your over all portfolio. This can help enormously in avoiding taking BIG LOSSES. A 1% loss is easy to absorb. A 30% or 40% loss in a trade is an account killer, and should be avoided at all costs.
Pros: Easy to implement and use.
Cons: Can place stops too close.
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3) Chart stop, a chart stop is where you place a stop that is either above or below a crucial chart level. The good thing about a chart stop is that this level is often used by other traders. That can both be a good thing and a bad thing, here’s why. Using either one of our first two examples only you know where the stop is. With a chart stop, a great many traders/brokers know that is where the stops are. In an illiquid market this type of stop should not be used, as many times brokers gun for the stops. In a highly liquid and active market this is a good stop to use.
Pros: Very easy to implement and use.
Cons: Can’t be used in thinly traded markets.
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So there you have it. Now you have all three ways to manage your money and protect your profits in the future.
Use stops…let them work for you.
President, INO.com
Co-creator of MarketClub.com
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Using the trade triangles and long stocks would you not recommend waiting
for a sell triangle? I’ve noticed if the stock dropped straight from the buy it would be a high percentage loss.I’ve puzzled over this.
thanks.
john
Hi John,
You should always place in a stop as an emergency exit. You are correct that if the trigger for a buy was met and followed by a sharp drop the percentage change could be rather large. This is why you always want to have a top in place. You may not receive a sell until a series of factors match up and trigger.
Since the triggers are build through an algorithm, they can’t always read what we would consider obvious moves, it will only really trigger when all the variables are given the go ahead.
Best,
Lindsay Thompson
Director of New Business Development
INO.com & MarketClub
In the past, I,ve used 8 or 10% stops and found myself stopped out of a position that went on to gain everything back the next day or two, and to then continue going up.
My question may be beyond the range of this article, but do you have any additional ideas as to how and when stops should be placed when I am following your trade triangle system.
Thanks.
Louis
Louis,
Thank you for your feedback. Most often folks use stops when they shouldn’t. Let me clarify that, if you have a very big volatile market it makes little sense to put tight stop on a position. You’re only going to get stopped out. With our Trade Triangle technology if you just used the reversal method there it takes into account the broad swings of the market and also when the markets tightened up. That way you stops tighten up as the market tightens up.
Unfortunately there’s no perfect fix solution for stops. My only recommendation is when the markets are volatile do not trade them and stand aside, or trade them but be diversified into several different markets.
All the best,
Adam
Hi,
A good Trailing Stop for long term strategy that I use is ATR(10) x 10= Trailing Stop. With this you have in to account the volatility of the market for your stop.
Hope this helps!
Stops are good but you should keep them to yourself. Don’t fill them in electronically unless you have an emergency. Let’s say you buy stock “X” at 20 and you want to stop loss at 18, you literally inform the market that you are willing to sell that stock at 18 but you don’t get money for that information.
Furthermore, never, ever, place a stop on an option unless it’s hugely traded; your order is certainly going to be executed.
I am using ATR as my Stop Loss. What I cannot finalise is the number of periods to use. Should I go with 14 period ATR or 2 x 5 period ATR.
Any thought on using ATR as Stop Loss?
Thank you for your feedback.
To answer your question I really don’t have any thoughts on using ATR as a stop loss tool. It could be excellent, but I really don’t have any first hand experience using that particular tool.
I wish I could say more, but that’s all I can say.
All the best,
Adam
I’ve been playing gold mining options and getting killed…just can’t seem to get out fast enough when the market turns. As you state, stops don’t work with options….am I in the wrong league, or what??
Dick,
I’m not sure how to answer you but here goes. One of the keys to trading is to find out what works for you and which markets don’t work for you. I found out early in my career that I was very good at trading Forex.
Every time I ventured into options, I found I wasn’t so successful. So guess what? I don’t trade options. I’ll stick to what I know best and that is trading in the stocks, futures and Forex markets.
That’s my advice.
All the best,
Adam
I like your article on stops Adam. If you get around to it. Could you add your view on trailing stops. And, the best stop of all. Hitting your target.
Stops are the most psychological testing for me at least, and can even test your confidence in the system you use.
Sorry Adam I just dont understand your methadolody. If your trade triangles are as effective as you would have us believe then why do you need to have stops in the first place. Your triangles should have told your subscribers when to get out in the first place. Right?
Peter,
Every trader has his or her own trading personality. As such different traders can handle bigger risks while other traders are risk adverse and can only accept smaller risks. That is why we show you three different stop types.
The Trade Triangles is a great way to use stops. The is what we use with the World Commodity Fund.
All the best,
Adam