Stops Vs. Drawdown

Discussion in 'Risk Management' started by ProfitTakgFool, Sep 9, 2008.

  1. How about a quick discussion on risk management. Constructive responses are welcome, non-constructive ones will be ignored. I pose the following question.

    You have <b>Trader A</b> who uses hard stops on each trade. This trader has a maximum down day of $5000 and will quit once he hits this number. On a hypothetical day Trader A goes in the hole by $2,000 but bears down and finishes the day up $1,000.

    On the flip side you have <b>Trader B</b> who also quits at -$5,000. Instead of using stops this trader uses money management and scales into trades at key levels. On a hypothetical day Trader B goes into the hole by $2,000 but likewise, ends the day up $1,000.

    All else being equal (this means you can't make up any conditions), who is the better risk manager and why? Before you share your thoughts/opinions remember, both have the same max down day and the same drawdown. The only difference is one trader is flat at minus 2k and the other is not.
  2. It's not really the case that Trader B doesn't use stops. Consider the following:

    - Trader A says, "If this position moves against me by 3 points I'm taking the loss, and will re-enter later."
    - Trader B says, "If this position moves against me by $5,000 I'm taking the loss, and will re-enter tomorrow."

    Since both have a $5,000 daily loss limit their theoretical risk is the same. Profitability will depend on the skills of the two traders. However, if Trader B doesn't have a hard "disaster stop" in place, not just a mental stop at -$5,000 open PnL, then I would say his risk is higher. For trader A, being stopped out at least forces him to pause and consider the situation.
  3. It's a matter of strategy. In both cases, if that's their strategy and they follow it then they are managing it well.

    It's harder to manage a "soft stops" strategy purely because rational thought gets more difficult as emotions rise and a $5000 loss might cause irrational behaviour. Or it might not.
  4. ggoyal


    i know you will say trader b is better because that is what you follow and are able to do well with it.

    however, im sure you know that doesnt mean other methods r wrong or are not as good. wtv works for the individual is good as long as he is disciplined.
  5. Trader B is a moron for not using stops. Such people take drugs to sleep at night while holding open positions without protection.
  6. You are right, I am Trader B and it does work for me but there are times when I wish I was Trader A. Being Trader B can increase your win rate but by doing that it can decrease your profit potential. For example, if you take 1 contract long and ride it down 10 points (just an example here) you have $500 of drawdown you took on and your average price will be reduced by that factor when you trigger 10 points lower. However, if you stop out after 2 points you only take on $100 of drawdown when you trigger 10 points below but here's the rub.....

    If you don't use hard stops you never get tagged and by not getting tagged you don't have those 1.5 point, 0.75, 1.25, etc....losses that add up over time.

    It comes down to this. Trading is an art and knowing when to use stops and when not to is a delicate thing to balance. Either trader has to manage risk.

  7. Profitability will depend on the skills of the two traders.------->>> This is the key. The question of whether to use stops or not depends on the skills of the trader.

  8. Neoxx


    Hi Profit,

    Isn't this the 3rd thread you've started contrasting money management vs stops? :D No complaints as it's all been interesting and informative reading, but I'm curious as to your motivation... is it:

    (a) debunking conventional wisdom and sharing alternative ideas (and so many times it will actually sink in! :D)

    (b) despite success, doubting your exclusive use of money management (presumption) and considering a middle-ground approach

    (c) other
  9. AFAIK the thing about your strategy is that it's counter-trend. There's a big difference in averaging down shorts in a downtrend or sideways market vs. doing so in an uptrend, as a means of accounting for noise. Today for example there were a couple of places where you might have shorted and seen the price run above your entry or break the last high. Averaging down in those places would have been a superior alternative to close hard stops as long as you believed the downtrend was still in play. Averaging down your longs at lower-lows to scalp minor retracements would have been a different matter and could easily have triggered that $5000 stop.

    The question for me is, since you seem to be able to get extremely precise entries, why not use this method to go with the trend (when there is a trend)? You should do no worse with the quick-profit trades but much better with the runners.
  10. Same results, just a matter of time.

    Trader A = slow death
    Trader B = one time blowup

    Money management = martingale …don’t trade without edge
    #10     Sep 9, 2008