If you have been trading commodities for any time at all, it is not uncommon to give stop losses a certain mystique, reverence, or maybe fear and loathing. This month I’m going to spend some time demystifying stop losses and show you two different ways to use VantagePoint to set stop losses.
Stop losses are a means to protect against excessive losses associated with your trading. They are not, however, guarantees. For example, let’s say you had a position in wheat or soybeans in recent volatile trading, and the markets went limit up or down against you. There is no guarantee that, just because you have a stop loss, you will be filled at that price – especially in a limit up/down market. Similarly, in a “fast” market (when prices are moving at the speed of light) your stop may be touched, but you may get filled several points away from the stop, causing a greater-than-anticipated loss.
These things happen from time to time and are unavoidable in trading. As a casual and unscientific observation, I have noticed that my stops are filled more or less as set in the electronic markets I trade, even in fast and limit move environments.
Stop losses are a common-sense means of managing risk and money. Stop losses set a predefined pain threshold, if you will, for loss. If we are smart about setting stop losses, we will take a moment to actually calculate how much money we will lose if our stop loss is hit and, knowing that, if we can stand to take the trade should our stop loss be hit. If not, maybe you should consider another trade with less volatility.
Stop losses are not a conspiracy against you. Trust me, I have been there. For example, in a recent Japanese Yen trade, my stop loss was hit, the market went 5 points above it and then went right back to where it was at the beginning of the day. I missed out on more than $1,200 of profit because I was stopped out. There are times when I think there is a fat guy in a cheap suit sitting in front of his computer screen just waiting to punish me by taking my stop. NOT TRUE.
So, how do we determine where to set our stop losses? First, you must understand that setting stop losses too close to the market’s movement will work against you and gradually and painfully eat away at the value of your account. Setting stop losses too close to the market is a sure-fire sign that you are a newbie to trading or have absolutely no faith in the trading system you are using.
