【Market】Where should the stop-loss line be placed?
Money Management Issues
“In trading, why is cutting losses important? Also, what are capital management and risk management? Answer briefly.”
There are many traders who are keen on timing trades, but perhaps many are not thinking much about how to protect their capital.
It is often said that trading is about cutting losses, but I have rarely seen articles that properly explain why this is important. It’s usually just advice like “don’t use too much leverage,” or something to that extent.
People often say it’s important to follow trading rules, but if you don’t understand why cutting losses is important, you cannot even create proper rules, let alone follow them.
Learn the correct way to set stop losses and aim to become a consistently profitable trader!
Answer
・To prevent bankruptcy of funds
・Capital management → adjust position size
・Risk management → set stop loss width
Explanation
The reason stop losses are important is, needless to say, to prevent bankruptcy of funds.
Trading is a competition for money using price fluctuations, so if you run out of money you cannot participate in the game.
In poker, it’s like losing a lot of chips.
No matter how high your win rate method is, if your funds are bankrupt, it has no meaning.
However, if you tighten stop losses too much to avoid depleting funds, even if the direction is correct, a small movement can trigger a stop loss.
Also, if you lower position size and leverage too much to suppress risk, and returns become small, there is no point in doing it.
(For example, if index investing yields 7% annually, but earnest trading yields 3% annually)
Prices do not move in a straight line; they move up and down, forming waves.
This wave width is called noise.
As long as the trend continues, you want to ensure your position is not cut by noise.
However, when the trend reverses, you want to close out as quickly as possible.
Therefore, it’s good to set the stop-loss line outside of the noise.
[Concepts for Setting Stop-Loss Width]
① When you correctly read the trend, avoid stopping out due to temporary moves in the wrong direction (do not make the stop-loss width too narrow)
② When the trend ends, close out as quickly as possible (do not widen the stop-loss width too much)
Turtle traders found by examining various securities that it should be 2 ATR or less.
For ATR, please refer to the previous article below ↓
The idea is that if the price moves in the opposite direction by twice the average daily movement, then it is not noise.
Turtle stop-loss lines
・When buying, buy price − 2 ATR
・When selling, sell price + 2 ATR
If the price moves in the opposite direction by 2 ATR, that is Turtle’s basic standard for stop-out.
A loss of 1 ATR per unit corresponds to 1% of the capital per unit.
A 2 ATR stop-loss would cap loss at 2% of the investment funds.
For units, please refer to the previous article below ↓
【Capital Management】Treating units as a concept
Important concepts for stop losses are
・When the trend is continuing, avoid being caught by temporary noise
・When the trend ends, exit immediately
These are the two basic policies.
Noise width differs by securities and timeframes, so it is important to study it yourself.
Because it is difficult to set stop-loss widths yourself, first use Turtle’s approach as a reference and aim to develop a trading rule that suits you!
Past verification data of trading rules using ATR is now公開
I will perform past verifications for you: “Verification of trading rules for the past 20 years”