Monday, December 2, 2013

Smaller stops, larger gains

After an in-depth survey of my trading results, I discovered that my best trades have the least maximum adverse excursion (MAE) or pullback. Many were under 5t. Therefore, I embarked on an investigation to figure out if it was actually possible to trade on a 5t stop if I chose my trades very carefully. The trick was to find a way to objectively measure the effectiveness of such a small stop and whether a larger stop (10t) would succeed on the exact trade if a 5t stop would fail. One way to do this was to have two stops, one at 5t and the other at 10t. And then measure fraction of trades that were successful on 5t stops.

The plan was to have two stops on entry at 5t for two contracts and 10t control for an additional contract. Once the price moves past the entry bar, all stops could be tightened to 5t.

The three possible results are:

  • both stops taken out: Trade was a total failure
  • 5t stop taken out, trade eventually fills at least 20t: Trade was a partial success
  • neither stops are taken out: Trade was total success

Preliminary results suggest that most trades that are stopped out with a 5t stop would also be stopped out with a 10t stop.

At this point results are preliminary and I do not believe I have sufficient data to draw a broad conclusion in all market conditions.

However, I do believe that for people whose success rate is under 60% or so, the benefits of smaller losses from tighter stops outweighs the small number of gains lost from partial failures. A 20t gain vs a 5t stop is a 4x profit factor and can greatly steepen your profit curve.

1 comment:

  1. Thank you for sharing this cadaver. Very useful information for those of us under the 60% win ratio! If there is anything else you can think to benefit us with low win ratios I'd be most grateful. Kind regards