Do you use a set limit? % or $? Does it depend on the stock? Market conditions? Volatility? I don't see many threads on this vital topic. I haven't started day trading yet, but I will soon. I have a pretty good strategy, on paper anyway. The only component I'm still debating is how to determine my losses. Any input?
There is guy by the name of John Sweeney who used to write for "Technical Analysis of Stocks & Commodities" magazine. He wrote a book about something called Maximum Adverse Excursion(MAE). Basically, you take all your trades, both winners and losers. You make note of our far AGAINST you each trade moved from the time it was innitiated to the time it was closed out. This is your MAE for each trade. Then you list these in the manner of a bell curve or other graphic representation. What you are trying to do is see where the optimum stop point should be. What is the best risk/reward. For instance, lets say most of your trades are winners of $1. Lets also say the MAE for the majority of trades is (.50), then you may want to set your stop at .55 so you capture the majority of winning trades. This example is very simplistic, but youl get the general idea.
I like to use trailing stops that increase based on how much the stock has moved since I've been in the position. I start with a base figure depending on the price and volatility of the stock. I'm also looking into volatility based stops. I read about these in TASC. They are based on the volatility of the previous x bars of the stock, so when the stock is in a narrow range, the stop is tight, but when it's highly volatile, it's a lot more open. This seems to allow you to stay in longer on the wild rides and get out quickly when the breakdown/out of a trading range occurs (Channeling Stocks dot Com Bob!)
Research determines the stop loss. Do a thorough analysis on how the stock moves. Never use stop limits, cause if they blow right through your limit price, you won't get filled, and will have to cover at a lower or higher price, depending ifyour long or short.
1. ATR some formula based on ATR (many use 150% of 30 ATR 2. Percantage of trading capital (many use 2%) 3. No stops (many mechanical systems use no stops) It would be imprudent for me to suggest trading without stops. You have to trust yourself (which is no big deal) and hope the system goes down at the right time (50/50 odds) One more tick Give me just one more tick
In my case it changes depending on the stocks I am dealing with, and what time of day it is, what the futures are doing etc. I trade only a few different stocks and my advice to you would be, do the same. Get to know a few. Watch what they do. Even on up days and down days there is a stair step in most stock's movements, before it continues in the direction it was moving. Say the stock your trading you know moves up and down 15 to .25, or whatever. If you are shorting or going long on no news or events tied to the particular stock, then either go long or short as the case dictates. If you enter at one of the extremes of the normal movement then keep your stops tight. If you get a less than perfect entry you will have a pretty good idea of how the stock moves and how much to give it. If you jump around to anything and everything that moves, big mistake, you won't have a clue what's going on. You won't know if it's normal wiggle or it's starting to change directions before it way too late. Hope this helps.
I would like to add some comments on that technique. In the graph below, I took the trades from a backtest and plotted P/L vs MAE, where MAE was plotted as MAE if P/L > 0 and -MAE if P/L < 0 (MAE usually is stated as a positive number), to fit a straight line to the MAE. In fact you should plot P/L vs MAE for long and short trades seperately. You may use this plot to search for cut-off points, i.e. ask yourself: if I stop these trades here, how many trades will turn into losers. The most important point then is to rerun your backtests with a stop set to the cut-off point you found this way (difficult, when you trade by discretion). To not do this is a severe mistake and I have seen articles on MAE where this step has not been performed (e.g. "Setting Stops and Taking Profits with Maximum Excursion" in TASC August 2002). Why is rerunning your tests important? Because when you cut-off your trades you exit them usually earlier than when not cutting-off and this influences all subsequent trades: you get different conditions for entry (and exit). The effect is then that you may get a different number of trades with different results from your previous test. The authors that do not rerun their tests usually have a list of their trades in Excel and just look at each trade what would have happened if it had been stopped at the cut-off point. Their results usually are too positive. In my experience (only a limited number of tests, but the other people did even test less) using MAE will lower your profits and hoepfully reduce your drawdown even more, i.e. the volatility of your equity might be reduced. Some trading systems do not react well to this technique, especially those using NNs. I suspect they have been curve-fitted a lot. Regards Bernd Kuerbs