Wouldn’t it be great if every time the market hit our stop orders, it carried on moving in the same direction for a significant move? Unfortunately, this is just not the reality of trading. Markets can sometimes move to take out your stop then reverse all the way to where your target originally was – and this can lead to a situation where you have trouble taking your stops.
Tracking the true cost of any trading error is an enlightening exercise and having trouble taking your stops certainly falls into this category. It’s easy to lose track of the actual difference in p/l especially when there are trades where you get away with the error. So taking the time to dig into your trade log and figure out the true cost is an important exercise.
It WILL happen to you
Another problem that we tend to face as traders is that we lean towards viewing an individual trade in isolation. So the fact that we might have taken many trades where the market hasn’t 1-ticked our stop doesn’t really enter into our consciousness.
However, the probability of it happening over many trades is much greater. Let’s say that the probability of your stop getting 1-ticked before the market reverses to target is 1%. If you take on average 4 trades per day and 20 trades per week, the chance of a 1-tick stop out before the week starts is 18%. Now that starts to be fairly significant.
Deception of feelings
The thing is, the market can make you feel like it’s going to 1-tick your stop way more often than it actually does. The way it approaches your stop can be nerve-wracking at times, but there are plenty of times when it will reverse before it actually hits it.
But that feeling can work against you when you move your planned stop before the market reaches it and then it doesn’t turn. Remember, your stop should be in a rational location and magnitude that if it gets there, the chances are high that something has changed in the market and you should get out. So changing it based on emotions is potentially catastrophic.
Market streaks and paranoia
Of course, if you are regularly getting unluckily stopped out just before the market turns, it could be that there’s something in need of attention in your trading plan – keep track of your results over time and assess whether the number of times it is happening is reasonable or not.
But even if you take a few unlucky 1-tick stops over a small sample of trades, it could also be that you are experiencing a market streak. When something happens in the world, markets can change their behavioral characteristics very quickly indeed and an increase in volatility could mean that your stop is too small all of a sudden. The behavior may not last, but it could leave an indelible mark on a trader’s psyche.
A paranoid trader not wanting to get cheated out of their money can add a large number of ticks to their losing trades – far more than the few stop-outs they save by moving their original stops.
Trouble Taking Your Stops
Recognition of the cost of not taking your stops is the first step to correcting the problem. The second major step is to see that over time, the chances of this happening become far greater. Mentally rehearsing taking your stop when you are unsure of whether the trade will continue much further against you is a powerful exercise to prepare you to execute your trades as you have planned – and inevitably, sometimes the market will 1-tick your stop.
For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.