Introduction
As a universal means of risk management is widely recommended to close the stop-order. It is recommended that you either directly, assuming that you risk only a small number of fixed points in a single transaction, either directly or indirectly, through phrases such as "control their losses, quickly cut their losses, etc. The truth is that in many cases, close the stop-order and may actually increase the losses. In terms of trade for the oscillations, we consider why similar stop-order and often do not work, how they manage to adapt to normal fluctuations in the market and how to compensate for this added risk. Finally, we also consider cases where the closest stop-order and can even be used.
Preface
I remember how many years ago, I tested its first mechanical system. Then I thought that if I set a stop-order, it will help to really make money. To my surprise, the system actually started to lose money. Why? The point is that the position of interruption before they start work. Suffice it normal market noise, to denigrate those stop-order before it was expected movement.
Market noise
Most traders frustrating situation, when shortly after their positions had been closed by stop order, the market is in the assumed positions in the area. In an ideal situation, you sign in your position, place a close stop-order and wait for when the market will move in the direction of your transaction. In reality, the market often moves in the direction of your transaction, but only after some hesitation in opposite directions, known as the market noise. This noise is often enough to cut close to the stop-order (see below).
Calculation and correction of noise
It is obvious that no one knows exactly where the market-based instruments will be traded in the future. However, judging by past movement, you can assume with some probability, where market-based instruments is likely to fluctuate in a given period of time. This can be measured by statistically valid methods, such as historical volatility and average true range. It can also be measured by simple visual assessment of the price chart.
Average True Range
Under the title, the average true range is considering a range of motion of the tool market, given GEPy. For example, schedule "Juniper Networks", shares of which are very volatile, we see that for the five-day campaign period is the average true range of more than 6 points (6.54). Over the long term (50 day) period of action is the average range for more than 7 points (7.21). Therefore, if we are going to trade on the oscillation (the period of retention, two - seven days) at market-based instruments like the "Juniper Networks", range of motion by at least 6-7 items a day, it would be unwise to try to close the stop-order ( say 1-2 points) and hoped that he would not be vulnerable.
Historical volatility
Historical volatility - this is the standard deviation of daily price changes, expressed as a percentage. In essence, this means that the historical volatility measures the extent to which prices fluctuate over time. Suppose the market instrument is traded for $ 100, and its historical volatility - 10%. At the end of the year the market will likely be traded somewhere between $ 90 ($ 100 - 10%) and $ 110 ($ 100 + 10%), the statistical probability of 66%, implying a normal distribution and that the variability remains constant.
If you take a long-term value of historical variability, and reduce it to the intended period of retention of position, it will allow you to assume what the market is a tool for commerce.
For the above actions of the "Juniper Networks" on condition that the action would be held within five days of 30.04.01g. We have a potential range from 46 1 / 2 to 71 1 / 2. This means that, with some probability (but not guaranteed!), Our position will not be closed to stop a warrant during the period of retention, if the stop order will be removed, at least at 12 1 / 2 points.
Visual assessment
Most technical analysis is done using a simple visual evaluation of the schedule. Just looking at a market instrument that is traded in a range from 40 to 50 in one day, falling to 39 the next day and zatemvozvraschaetsya to 50, it is possible to conclude that the variability of such a tool. Therefore, any less good trader is unlikely to rely on trading on the instrument, use the stop-order in 1-2 points.
How to manage risk
When you trade in a more volatile market-based instruments, you certainly can not simply extend the range for its stop-orders, without compensation at risk in one way or another. You must keep the overall risk and to manage the size of your positions, respectively. For effective risk management to take risks for no more than 1 - 2% of your trading capital in one transaction. Therefore, in general, you can sell a large number of lots in the less volatile market-based instruments and to reduce the number of lots for mobile and fast-volatile instruments.
Managed Funds
Remember that risk management is an integral part of the overall money management, and use a wider range for the stop order has no meaning without the management of money. It is obvious that you should make sure that, on average, you take much more of the open positions, than risk losing. For example, you can not take risks 5 points for each transaction, making an average of only 1-2 points. Mark Bucher calls such strategies "anthills". Ants can make a substantial mound of small particles, but it only takes one big trail of shoes, so that all of this crush. Therefore, make sure that your income is sufficiently large to justify a wide range of stop-orders.
Cases for the close stop orders
Now, when we discussed the dangers of close stop-orders, let us consider the cases where the closest stop-order and can even be used. It depends on the technical model and / or if you want to re-enter the market, after you close the stop order will be struck.
Technical model
In many cases, market-based instruments should not violate the technical model. If it does, it can be assumed that the model has failed. Therefore, in such cases, the stop-order may and probably should be placed outside the model, even though it often is in the normal market noise. An example of such models can serve as short-term situations such as dense low variability grounds. For example, look at the picture below, as a hypothetical market-based instruments makes narrow consolidation after a strong upward movement. Market-based instruments should not go beyond the grounds of the consolidation. If it does, it can be assumed that market-based instruments observed peak. Therefore, it provides a logical reason for placing the level of stop-order.
Keep in mind that trade is not always all it is by the rules. Sometimes, the markets will make a false movement following the consolidation before the resumption of its long-term trend. However, you must comply with its stop-order, because when such a situation, you do not know if this is a false movement of (a) or removal of the model (b). This leads us to our next question - the re-entrance.
Re-entry
If you want to carefully control the position and have the discipline to perform re-entry after the closing position on a stop-order, the more immediate stop-order and can be used, even in volatile market-based instruments. This is especially true in the short-term situations with low variability. However, in general, keep in mind that many small losses and can often add up to a much greater amount than a big loss, especially given the spread and commissions. Also, keep in mind that the strategy of re-entry, probably best suited for those who are accustomed to take many small losses and has some experience of intra-day trading. If you are unable to monitor screen, or you are not psychologically prepared to re-operate on market-based instruments, on which you have just been shut down (sometimes many times), then you should use a broader range of orders to stop and allow the position to turn how do you expect.
The golden mean
The more close to the stop order, the more likely your position on it will be closed. However, by placing the stop-order level, where the statistics suggest is too far a distance to market noise, you can be confident in its invulnerability. Therefore, you can use the "golden mean" and place your stop-order somewhere between these two extrema. In this case, you will be sure that your stop-order is within the normal market noise, but it is less likely to be vulnerable, rather than a very close stop-order.
Conclusion
Close stop-order, which many used to reduce commercial risk, in fact, may increase the risk because they are more likely to be struck because of the normal market noise. This reality must be taken into account, in your terms of trade. In this article we have only touched upon the topic of variability, money management, and technical models. If you are going to succeed as a trader, you should explore these issues more deeply.
As a universal means of risk management is widely recommended to close the stop-order. It is recommended that you either directly, assuming that you risk only a small number of fixed points in a single transaction, either directly or indirectly, through phrases such as "control their losses, quickly cut their losses, etc. The truth is that in many cases, close the stop-order and may actually increase the losses. In terms of trade for the oscillations, we consider why similar stop-order and often do not work, how they manage to adapt to normal fluctuations in the market and how to compensate for this added risk. Finally, we also consider cases where the closest stop-order and can even be used.
Preface
I remember how many years ago, I tested its first mechanical system. Then I thought that if I set a stop-order, it will help to really make money. To my surprise, the system actually started to lose money. Why? The point is that the position of interruption before they start work. Suffice it normal market noise, to denigrate those stop-order before it was expected movement.
Market noise
Most traders frustrating situation, when shortly after their positions had been closed by stop order, the market is in the assumed positions in the area. In an ideal situation, you sign in your position, place a close stop-order and wait for when the market will move in the direction of your transaction. In reality, the market often moves in the direction of your transaction, but only after some hesitation in opposite directions, known as the market noise. This noise is often enough to cut close to the stop-order (see below).
Calculation and correction of noiseIt is obvious that no one knows exactly where the market-based instruments will be traded in the future. However, judging by past movement, you can assume with some probability, where market-based instruments is likely to fluctuate in a given period of time. This can be measured by statistically valid methods, such as historical volatility and average true range. It can also be measured by simple visual assessment of the price chart.
Average True Range
Under the title, the average true range is considering a range of motion of the tool market, given GEPy. For example, schedule "Juniper Networks", shares of which are very volatile, we see that for the five-day campaign period is the average true range of more than 6 points (6.54). Over the long term (50 day) period of action is the average range for more than 7 points (7.21). Therefore, if we are going to trade on the oscillation (the period of retention, two - seven days) at market-based instruments like the "Juniper Networks", range of motion by at least 6-7 items a day, it would be unwise to try to close the stop-order ( say 1-2 points) and hoped that he would not be vulnerable.
Historical volatilityHistorical volatility - this is the standard deviation of daily price changes, expressed as a percentage. In essence, this means that the historical volatility measures the extent to which prices fluctuate over time. Suppose the market instrument is traded for $ 100, and its historical volatility - 10%. At the end of the year the market will likely be traded somewhere between $ 90 ($ 100 - 10%) and $ 110 ($ 100 + 10%), the statistical probability of 66%, implying a normal distribution and that the variability remains constant.
If you take a long-term value of historical variability, and reduce it to the intended period of retention of position, it will allow you to assume what the market is a tool for commerce.
For the above actions of the "Juniper Networks" on condition that the action would be held within five days of 30.04.01g. We have a potential range from 46 1 / 2 to 71 1 / 2. This means that, with some probability (but not guaranteed!), Our position will not be closed to stop a warrant during the period of retention, if the stop order will be removed, at least at 12 1 / 2 points.
Visual assessment
Most technical analysis is done using a simple visual evaluation of the schedule. Just looking at a market instrument that is traded in a range from 40 to 50 in one day, falling to 39 the next day and zatemvozvraschaetsya to 50, it is possible to conclude that the variability of such a tool. Therefore, any less good trader is unlikely to rely on trading on the instrument, use the stop-order in 1-2 points.
How to manage riskWhen you trade in a more volatile market-based instruments, you certainly can not simply extend the range for its stop-orders, without compensation at risk in one way or another. You must keep the overall risk and to manage the size of your positions, respectively. For effective risk management to take risks for no more than 1 - 2% of your trading capital in one transaction. Therefore, in general, you can sell a large number of lots in the less volatile market-based instruments and to reduce the number of lots for mobile and fast-volatile instruments.
Managed Funds
Remember that risk management is an integral part of the overall money management, and use a wider range for the stop order has no meaning without the management of money. It is obvious that you should make sure that, on average, you take much more of the open positions, than risk losing. For example, you can not take risks 5 points for each transaction, making an average of only 1-2 points. Mark Bucher calls such strategies "anthills". Ants can make a substantial mound of small particles, but it only takes one big trail of shoes, so that all of this crush. Therefore, make sure that your income is sufficiently large to justify a wide range of stop-orders.
Cases for the close stop orders
Now, when we discussed the dangers of close stop-orders, let us consider the cases where the closest stop-order and can even be used. It depends on the technical model and / or if you want to re-enter the market, after you close the stop order will be struck.
Technical model
In many cases, market-based instruments should not violate the technical model. If it does, it can be assumed that the model has failed. Therefore, in such cases, the stop-order may and probably should be placed outside the model, even though it often is in the normal market noise. An example of such models can serve as short-term situations such as dense low variability grounds. For example, look at the picture below, as a hypothetical market-based instruments makes narrow consolidation after a strong upward movement. Market-based instruments should not go beyond the grounds of the consolidation. If it does, it can be assumed that market-based instruments observed peak. Therefore, it provides a logical reason for placing the level of stop-order.
Keep in mind that trade is not always all it is by the rules. Sometimes, the markets will make a false movement following the consolidation before the resumption of its long-term trend. However, you must comply with its stop-order, because when such a situation, you do not know if this is a false movement of (a) or removal of the model (b). This leads us to our next question - the re-entrance.
Re-entryIf you want to carefully control the position and have the discipline to perform re-entry after the closing position on a stop-order, the more immediate stop-order and can be used, even in volatile market-based instruments. This is especially true in the short-term situations with low variability. However, in general, keep in mind that many small losses and can often add up to a much greater amount than a big loss, especially given the spread and commissions. Also, keep in mind that the strategy of re-entry, probably best suited for those who are accustomed to take many small losses and has some experience of intra-day trading. If you are unable to monitor screen, or you are not psychologically prepared to re-operate on market-based instruments, on which you have just been shut down (sometimes many times), then you should use a broader range of orders to stop and allow the position to turn how do you expect.
The golden mean
The more close to the stop order, the more likely your position on it will be closed. However, by placing the stop-order level, where the statistics suggest is too far a distance to market noise, you can be confident in its invulnerability. Therefore, you can use the "golden mean" and place your stop-order somewhere between these two extrema. In this case, you will be sure that your stop-order is within the normal market noise, but it is less likely to be vulnerable, rather than a very close stop-order.
Conclusion
Close stop-order, which many used to reduce commercial risk, in fact, may increase the risk because they are more likely to be struck because of the normal market noise. This reality must be taken into account, in your terms of trade. In this article we have only touched upon the topic of variability, money management, and technical models. If you are going to succeed as a trader, you should explore these issues more deeply.
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