I got this question last week from a DTS Member. The question is so important I thought I would share my response with everyone. On the surface the question is obvious: how do I keep from losing too much? But there is much more to consider than placing a “tight” stop whether you are trading with the DTS Falcon Swing Trader, one of the other DTS Birds or another system altogether.
First off, it is important to remember the size of your stop is totally adjustable. Assuming you’re using Trade manager, if your selected stop strategy is too large simply select another strategy from the Trade Manager menu and/or tighten the parameters of the strategy that you’re using. This can be done even if you’re not using the Trade Manager to control you stop loss orders, but adjusting your stop is easier if you are trading with the Trade Manager.
The important thing to remember is to keep your risk constant. Ideally risk should be limited to less than 5% of your account, with 2% considered the ideal. So if you’re trading a $20k account and risking 2% per trade that means you will have $400 at risk. So whether your stop is 20 ticks or 200 ticks the risk amount does not change. The only thing that changes is the number of contracts traded. That’s what Trade Manager does for you automatically. And it is a very important concept to understand!
While it is tempting to keep stops tight to “minimize risk”, remember that your risk amount is a constant percentage of your account, so try not to strangle your trades. Case in point, I had an interesting conversation with a student last week, who tries to limit his risk by keeping his stops at a constant 15 ticks ($150) trading Gold. I suggested his stops might be too tight for that market, but he said he needed to keep them that tight to minimize his risk.
He called me one day, quite upset that he just lost $600. I was also trading Gold that day and made $1000. I said “how could you possibly lose money today? Gold was rallying like a rocket!” He said that for each of his trades the stop got hit just before the market rallied. In other words, his stops were too tight. So tight that he only lost money while my “looser” stop allowed me to make money.
Remember the sole purpose of a stop loss is to keep you from busting your account, which is why we limit risk to a percentage amount instead of a tick amount. A stop loss only matters if it gets hit. It the stop never gets hit it doesn’t matter how far away it is. Give your trade a chance. Don’t place your stops so tight that you never have a chance to profit. Remember to limit your risk by limiting the percentage of your capital you have at risk per trade, not by limiting how far you’ll allow the market to move against your position.
It might seem like a fine line, but it will make all the difference between a profit and a loss.
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