Risk management should be one of the most important tools in a trader’s arsenal of trading expertise. Develop a clear set of rules and criteria on how to use and place stops accordingly in each of your predefined strategies. Stops are a critical ingredient of a trader’s formula for success.
Note:
Stops are not fail-safe. With limited experience, they can create a false sense of security. They can also lead to slippage. There is no guarantee that your position will be closed out exactly where you would like it to.
Different Types Of Stops
| Fixed Dollar Stops | Orders used to limit the specific dollar amount that can be potentially lost on a trade. |
| Percentage Stops | Orders used to limit the percentage of capital allocated to the trade that can potentially be lost. |
| Timeframe-Based Stops | Orders that are composed of a time dimension that upon expiration will close out the trading position. |
| Technical Analysis Based Stops | Orders that are derived from some technical measurement that is a derivative of price and volume. Some variations of technical stops include trailing stops and breakeven stops which may be fixed-dollar based, percentage based or timeframe based. |
Each trading strategy should have a suite of risk management tools, including stops associated with it based on the trader’s style and philosophy.
Share Size Lots
Another major component to successful trading is share size lots. The success of your trading will be directly tied to how you specify and determine the number of shares you will trade. By determining your share size methodology, you can allocate different share/contract sizes (lots) to each of your strategies.
Maximum Loss Limits
Trading habits should include opportunities for traders to learn their craft. Having pre-determined loss criteria for trade losses, weekly losses, and monthly losses can provide a potential safety net for a trader to regain composure and confidence.
The following table is a framework that requires the trader’s input to provide some level of assurance to the trader’s habits. The trader should change and adapt the following items to reflect his/her trading style.
Maximum Loss Limits
| Trade Limit | If the last trade losses are greater than $X, the trader should determine what course of actions to be taken, including NO MORE TRADING for the rest of the trading day (i.e, shutting down the trading platform for the day). |
| Weekly Limit | If the weekly cumulative loses plus your last trade losses are greater than $Y, the trader should determine what course of actions to be taken, including NO MORE TRADING for the rest of the trading day (i.e, shutting down the trading platform FOR THE DAY and refrain from trading the REST OF THE WEEK). |
| Monthly Limit | If cumulative monthly losses plus your last trade losses are greater than $Z, the trader should determine what course of actions to be taken, including NO MORE TRADING for the rest of the trading day and the trading week and the remainder of the month (i.e, shutting down the trading platform FOR THE DAY , refrain from trading the REST OF THE WEEK, and FOR THE REST OF THE MONTH). |
Overriding Maximum Losses
By knowing where to place acceptable stops for your trades, one can be proactive in trying to prevent oneself from risking more than necessary or from being stopped out for some reason. An accumulation of losing trades usually creates a trading mentality that can lead to disastrous outcomes if not managed and monitored properly.
Often, stops are placed too close and will get hit needlessly if they are within the normal volatility of the market. These actions and others usually lead traders to change their risk tolerance midway throughout the trading day, week, or month. This section should outline the rules and criteria to be used if a trader decides to override his/her maximum loss thresholds.
