Jun
Stops Are Not Important, Its The Odds Of It Getting Hit That Are
Figuring out the proper stop loss when day trading, whether experienced or novice, is always a tricky subject. One thing is most certain, those traders that consistently do not use stop loss orders face almost a 100% chance of losing a significant amount of money, if not all of it. Even the prudent use of stops, if they are placed in the wrong area, will result in consistent losses no matter how good the stock idea is. In addition, adding positions before market moving news events occurs can assure increased volatility and increased odds of stopping out.
The main thing to keep in mind is CURRENT MARKET CONDITIONS – I cannot stress this enough. Not what the Dow Jones Average is doing, it is what many stocks are doing overall and how they are trading. What is the volatility level – are they slow and steady or whipping up and down on the slightest market move? This makes a huge difference is not only your stop, but the risk level involved. Most people assess risk by the amount one can lose when using a day trading robot or just trading on their own with chart setups. What most people fail to think about is the actual odds of that loss happening.
While there is no sure fire way to figure out odds, if you watch what other stocks are trading like you can get a pretty good idea. If current conditions are calm, you can usually use a smaller stop amount and still have decent oddsit will not get hit. When more volitile conditions are present, using a smaller stop is a really bad idea because of the significantly higher odds that even a smaller than normal oscillation in price will hit your stop.
The way you figure the odds in a stop happening when day trading is somewhat straightforward. Look at the average range high to low over the last 20 minutes. Do not pick the most calm period of time, as this tends to not stay constant. If the price action currently is very flat and calm, go back on the chart to a more volatile time of the day or prior day and then figure out the range. It does not need to be an exact amount, we are just looking for an approximation. Once you have measured this range, this becomes your maximum risk.
What the best thing to do is to try to lower the max amount to a much lower level. This can be done 2 ways. The first way is to study the pattern of trading behavior for that stock locallly when it reaches a prior high level – does it normally fade back or does it have momentum and push through? If it tends to push (last few times it reached a high turn point), then its ok to buy the stock on strength. If it tries to sell, or looks like a fade back – wait for it to push and then put your order in at 1/4 of the range computed, but lower than the high its at currently. So if the range was 1.00, and the current price is at around 40 now, you would look to place your order at 39.75 to put on a long. You will most likely miss some trades doing it this way, but have to ignore the urge to chase the prices. If a similar pattern is occurring on a lot of other stocks (in general) you have to be extra careful.
The second way to lower the risk is to split your order into 2 parts. So if your trade size you want is 500 shares, just buy 200 shares now. Wait until it pushes a decent amount up (meaning it has pushed enought that it has moved past the fade the breakout move area), then look to add the other 300 on a 5 or 10c dip. Move your stop price up higher .45 now (figuring you have a 1.00 stop to start) on the whole thing. The other alternative, if the market tends to fade the push moves, is to buy 200 shares now, then put the balance of your order .25 above your stop (assuming it is 1.00). The maximum stop loss level should remain the same on all the accumulated shares. The difference here is if market conditions get poor for going long when day trading for a period of time, you are going to lose a lot more averaging when its selling because you will get filled on the add, then stopout 2 minutes later on all of it.
The easiest way around this situation is to lower your share size – when upredictability sets in, trade only 1/2 your normal size. The name of the game to being more profitable is to preserve capital with stops, and secondly to place the stops in the right way to avoid making a loss too easy for the market to hit. While its impossible to tell when conditions improve unless you are actually trading, there is nothing wrong with playing less shares until you see it look better over time.
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