Q&A Corner: I answered questions that came to the blog! This is a question about stop positions for swing trading.

Q. I have trouble deciding where to place stops when doing swing trading. When I tighten the range, I end up placing stops too quickly, and when I widen it, the losses become large. How do you decide?

A. The answer to the above question is,to flexibly adjust three points: position size, stop, and allowable loss amount. That is the answer.

First, decide the allowable loss amount.

Next comes the stop position.

And finally, decide the position size.

1) Allowable Loss Amount

This is the maximum amount you can tolerate when the trade incurs a loss. I set the allowable loss amount to 2% of the capital. For example, with 1 million yen, the loss limit is 20,000 yen. With 10 million yen, the loss limit is 200,000 yen. And so on.

An important consideration when deciding the allowable loss amount is to avoid compounding trades. There is no 100% win rate in trading, and losses may occur in a row. If a string of losses depletes funds, you must avoid shrinking the trade size. Therefore, I always plan for the worst-case scenario and manage funds accordingly.

2) Stop Position

The stop position varies depending on conditions, so I’ll skip detailed explanations here, but I’ll list a few simple approaches.

Setting based on recent highs and lows. Setting based on round numbers or psychological levels. Setting at neat numbers such as 100 pips or 200 pips. However, no matter which criterion you use to determine the stop, I aim to keep the risk-reward ratio at least 1:1.

3) Position Size

Once the allowable loss amount and stop position are determined, the position size naturally follows. This is the profit/loss calculation formula.

・For cross-yen pairs: (pips gained × 100 yen) × position size (units: 10,000 units) = profit/loss
・For other pairs: (pips gained × 1 unit) × position size (units: 10,000 units) × yen rate = profit/loss

If you substitute the stop position and loss amount into the above formula, the position size comes out.

Finally, I adjust both the allowable loss amount and the position size based on trading confidence. For example, when I am confident about a trade, I set the allowable loss amount to 2% of my own funds. When I am not confident, I reduce the allowable loss amount to 1% or cut the position size in half and enter in split orders. I also view this as risk management.