Stop Losses are for Sissies… (2)
The title of our blog discussion already prompted reaction from our traders… Paul admits that if using stops makes him a sissy then he must be so when it comes to trading. Along the same line of thought I must admit to be one too, and I believe most professional traders could also be considered “sissies”, for the same basic reason: they refuse to trade without stops…:) Don’t worry Paul, I was just trying to make a point - neither I nor any of our instructors would ever advise anyone to trade without a protective stop… However this myth circulates among traders, we have heard this phrase more than once, which is exactly why I think it is important to clarify certain points with regard to the use of stops when trading on Forex.
I mentioned from the very beginning that we are considering the “sissies” to be more sensible then the “neckbreakers”, and in what follows we will explain some of the reasons why. However, those who believe trading without stops is preferable have some arguments of their own, that I will try to expose in brief in today’s article. So, why do the “neckbreakers” prefer “walking on a tight rope without a safety net”, as Sunil put it?
First, there is a technical argument. Some trading platforms suffer technical problems from time to time, and as a result price sometimes displays huge spikes of hundreds and sometimes even thousands of pips up or down in only a few seconds. Of course, any stops at any distance in the direction of the spike will be wiped out instantaneously, and the trader will get his trade closed for no reason, while all the other platforms perform without any problem. I suppose we can all understand that such a situation could make any of us mad…
Some traders believe that not using a stop at all will protect them from such situations. If their trading balance is big enough compared to their positions in the market, they might be right, too… These spikes are essentially errors, and they are corrected in a matter of seconds, after which price goes back to its normal movement. Our traders may be right inasmuch their trades would probably not be stopped out by such rare events. However, I personally experienced this problem with all the brokers I have worked with and I can say that even if my stops were hit on such an erroneous spike, all positions were eventually rolled back and I got out of the situation with no harm or loss of any kind in my account. Once I was even credited an unrealized profit just because without the spike I might have reached the target of my trade!
Of course, these highly improbable events are still possible and your broker may not be such a nice guy, so there is a possibility that you lose something after such a problem after all… Nevertheless, this is definitely not an argument in favor of not using stops when trading, due to some very sensible reasons: 1) these events are very rare; 2) even if they happen, respectable brokers always roll back all positions after the event so no harm is done and 3) even if your stop is hit- if it was placed correctly - this will not be a catastrophe and your account will not suffer much anyhow, so there is really no reason to make such a big deal about it.
Then, there is the argument of stop hunters… I must admit I personally consider this to be a point to be taken seriously, as all of us know there are many stop loss hunters out there, and placing our stops close to the market price will give them the tools they need to fight individual traders and win the battle. Especially brokers which act as market makers can manipulate price action in such a way that stops have a high probability to be hit if they stand around certain key levels… Basically, what the neckbreakers say is that they do not want their money to go to such sharks, and they prefer to keep their stops mental.
My answer to all this is yes, I admit such things may happen, and as much as that might bother us it is not really in our power to change market mechanisms and realities that have been there for decades… However, I would like to draw attention to 2 important points: placing a stop and getting it hit by a stop hunter is definitely annoying, but we must be smart choose the smaller risk…If our stop gets hit, we will live to trade another day, however if our trade goes hundreds or thousands of pips against us there may be no tomorrow for our trading account. The market is sometimes punishing us, and this is part of the business, what is harder to accept is to end one’s career just for being proud enough not to place a protective stop. Secondly, this reality prompts us to set intelligent and technical stops on our accounts and not mere dollar-value or round-number ones… Placing a stop is one thing, HOW and WHERE we place it, well, that’s an entirely different story… And this is where education can make the difference between a successful trader and one who can only watch some charts on a demo, wondering “what if”.
Thirdly, there is the “I know what I’m doing” argument. I mean, some traders just “KNOW” the market will go up and down, and as a result they feel no need to place a stop since there is nothing to be protected against (If the market WILL go up, it can’t go down at the same time, right?). I think there is no need to comment on such a childish attitude, and of course any trader who thinks like this has no idea in what danger he is placing himself… Actually, it doesn’t even matter much if he places stops or not, unless he changes his view of the market failure will be for him just a matter of time - maybe not today, maybe not tomorrow, but eventually the market will eat him up and feed his account to the sharks.
Will be back with some more pros and cons on using protective stops…
