Tight stops?/ Loose stops?

Posted by Art thoughts on August 26, 2016 in Bids and Offers

     Tight stops, loose stops.  Which tend to be preferable?  I published a recent article that showed how even very close stops can sometimes improve system performance to surprising degrees.  That strategy means betting more on the relative anomaly than on everyday market behavior.  Your percent profit figure will decrease since quick losses will be commonplace.  The system’s success hinges on the fewer runaway trades—those that trend early and never look back.  You get a smaller number of wins with averages dwarfing that of the losing counterparts.  You’re betting (and profiting on) the relatively infrequent event.

     There are several components to a performance summary; net profit being only one of them.  That figure will usually get smaller as your stops are tightened, but your worst drawdown will also lessen.  The stat I’m most interested in is the return on account; the net profit divided by the maximum drawdown.  The resulting number will be a percentage your account would have increased up to the ultimate net profit starting with the worst drawdown amount.  It is more significant than the mere net profit because it gives you an expectation in relative terms.  A system that made $40,000 with a worst drawdown of $8000 is vastly superior to one that earned $100,000 after drawing down $80,000.  You could trade three contracts on the former and get both a better net profit and a vastly improved worst drawdown.

     The interesting thing about my recent stop optimization study is, while I’ve improved some expected stats like lesser drawdowns and better return on accounts, in some cases, even the bottom line increased.  This is not to say that tighter stops are always preferable.  Sometimes risking less per trade is actually more risky overall, counter-intuitive as that may seem.  You’ll get trades where an otherwise quick loss will turn into a longer term mega-profit.  Conversely, if the stops are tighter, less small losses will become big losses. 

     It’s not a once-size-fits-all proposition.  Determining what stop sizes are optimal for a given system is no different that discovering all other aspects of your system.  Keep your preconceptions to a minimum and like any good scientist, go where the evidence takes you.

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