This week I didn't have any new principle discussion prepared (busy with Christmas preparations, and a bit of slackness on my behalf).
However I was asked today by the Hot Copper member @justinh a question about stop placement.
This is a really big subject, and I only really scratched the surface here.
I repost the question and my response here.
Hi Jako I was watching this video presented by Davis Weis on springs where he went through the following chart attached. I've arrowed the support in red under which I've marked '1' and '2' as the two potential springs. If you looked at trading it and got in based on bar '1' with your stop just below the low, you might've been just stopped out at '2' only to then see the market rise successfully. Apart from setting a lower stop, how would you avoid this and other similar scenarios?
Remember on a slightly larger timeframe, there may not have been two dips lower, just one.
For instance, if that is a 5 min chart. On a 10 min chart that may have been just one bar (which completely avoids the problem-but is not a satisfactory answer).
Actually on a later chart, he mentions that you could get whipsawed out of such a trade, buying at the "danger point" as opposed to buying higher up where it's more "probable".
Yes, David is partial to trading right down near the danger point, as he believes that is where risk is lowest, because stops can be placed closer (see below)
Anyway yes being whipsawed like that can be an issue, and one that causes traders difficulties around the world, from time to time.
Firstly, many professional traders say that stop loss placement should be dynamic, not fixed, and should be adjusted regularly as the price action unfolds.
Some serious professional Futures traders who are only trading for the short term (or are scalpers) only place a 'Hard Stop', and their actual stop loss is mental. However, trading this way takes some serious discipline.
It means that your hard stop is in place only to protect 'your account' and is set quite a long way from your entry. You want to avoid having your hard stop hit, because it will mean taking a significant loss, however it is there only to protect your account (not necessarily THIS position). Then you have a mental stop in place that you will manually use if the price action is not going your way, and you have read the market wrong. You must have the disiplin to cut the position though, because you want to avoid the Hard Stop being hit in almost all circumstances, except emergencies.
Secondly, you could have a rule where you don't enter until price begins sweeping past the high of the initial spring bar by a certain margin (by two pips for instance, or whatever amount you choose). That would normally avoid some of these cases, but price could always come back for a test of the spring and still 'get you', so this sort of issue is certainly not uncommon and cannot be totally avoided.
I remember watching a live webinar with David and Dr. Gary, where David opened a position right down at the lows of range, which David was 'pretty sure' would be THE low for the day (for numerous reasons). Trouble was....price actually bumped along the lows for about an hour before price started moving favourably.
So (not knowing this) he opened his position early, and price rose a few pips for a little while, and he slid his stop up just a little (to reduce risk), and price came straight back and stopped him out for about a $25 loss. So he watched for another bar or two (on a 5 min chart I think), confirmed his thoughts, and opened another position right down at the lows again.....then slid his stop up again, and got stopped out again for a small amount. He then watched for another bar or two and was still quite sure this was going to be the low, so he opened again at the lows, and quite quickly price then accelerated higher and never looked back. He held this position for almost another hour and made well over a grand.
That was Davids way of trading it (he didn't mind taking very small losses at the extremes of a range).
It a similar situation, Steve Phillips would have had a really deep hard stop, and then just watched the price action and allowed the piece to fluctuate (he would have seen a small profit, then a small loss, then a small profit, then a small loss), then as soon as price started to move, he would have a new mental stop in mind, which would change regularly as the trade progressed (he said when he first used this method, he would write the new mental stop level on a piece of paper (it was always variable though, depending on the price action). Steve usually kept a fairly wide stop until something happens to suggest the trend may change, then he tightened it up more and more (as the price action confirmed his thoughts), until he was stopped out.
Note that both these styles opened the position fairly early, which can reduce the success rate, but increase the profit margin, and also reduces the risk (as the initial stop or mental stop, can be closer to the opening price)
Gavin however (who was generally a very short term scalper) would often use the rising buy method in this same situation, and would only enter after price had moved a certain distance above the spring....as that showed price had some 'intent' to move higher in response to the spring (he felt this showed the spring 'would work'). This method increases the success rate, but reduces the potential profit margin, and also increases the risk (as the initial stop-when opening the position-would be wider).
There are pro's and con's for each method, none is perfect.
It depend on your own personality, the timeframe of the trade, your risk profile, your account size, etc., and which method appeals to you (or you might develop your own method). (perhaps try each style and see how it goes)
Finally, while a lot of players use structure to hide their stop behind, longer term players will sometimes use levels instead. For instance, looking at the maximum average true range (ATR) over a period (depending on the expected holding time), and setting the stop a little wider than the maximum ATR.
So if you expect to hold for a year or more, and you find the maximum ATR for the last year was X, then you set your stop at X + a few pips. This will keep you wider than any one single days movement in the last year, and allow you to reassess the position as price unfolds.
As you can see, stop loss placement is a pretty big subject, and we have probably only scratched the surface here, but at least it offers something to think about, and some different methods to consider.
