Sunday, September 26, 2010

Stop placements (again!)

While being away from the market for a few days, I have been pondering on how I can improve my returns even further. Again, I looked to the Turtles trading method for inspiration.

Currently I am placing both the initial and trailing stops on the S1 system at the 10 day low/high. The Turtles used two stops - one placed on 2 x ATR for the last 20 days, as well as the 10 day low/high. However, on the day that a position was opened, they used a much smaller multiple of ATR as an initial stop. The thinking behind this was that, if a trade was going to be profitable, it should go into profit straight away. There were two consequences of this:
  • the initial stop would be placed much closer to the entry price. All things being equal, if a fixed fractional money management strategy was being used (i.e. 2% of equity was being allocated to each trade), then having a closer initial stop would mean that a much larger position could be opened, wothout increasing the overall risk;
  • If a trade did not show an initial profit shortly after opening position, the trade could be cut, freeing up capital to look for other new positions.
I initially took the Turtle system and simplified it, to suit my basic needs, however I have found myself re-incorporating many of the additional rules of the Turtles system. (for example, on my S1 system I am now using the rule of looking for a previous breakout that failed as a trade filter).

The issue I have with placing my initial stops much closer is that, with stocks, you have to be aware much more of opening gaps, widening spreads etc, which you encounter a lot less than when trading commodities or currencies, for example.

I do agree with the theory that entering a breakout trade should go into profit almost immediately, however the question of the trailing stop placement is still a question I need to get clear in my own mind, before I make any changes.

Those of you who are tracking my performance history log will see that, while the percentage gains on individual trades are impressive, the reward:risk ratio is somewhat lagging. It would be nice to find a solution that I can rely on, that will improve that ratio, without placing the initial stop so tight as to be whipsawed out of the trade.

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