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trailing stop loss

The trailing stop loss is one of the most counterintuitive aspects of trading. Your mind screams either: "make it tighter, I don't want to lose profits," or yells:" don't make it too tight; I don't want to get stopped out." The average result is a stop set somewhere in the middle, which typically gets stopped out for a substantial loss of profits, and shortly after that, prices advance again and see new highs, which drives a trader mad. Not only has he or she given up substantial profits, but now also sits there with "fear of missing out" seeing prices advancing again.

So how do you place a sensible stop?

Skipping all sorts of stop methodologies that statistically have little merit, the next best thing is a chandelier stop. Stop calculations with this methodology are based on the principle that the farther price is advanced, the tighter the stop gets. The idea is that action-reaction principles apply where extension return to the mean, and the more standard deviation has been extended, the more likely a snap back awaiting. As such, the stop calculation is set from the price levels in smaller and smaller units the more price exceeds.

While there is logic to this approach, and it can be computerized, it still produces poor results.

What we use is a quad exit, which solves a multitude of problems. The Quad mainly resolves the psychological issue that an all-in/all-out approach presents, where instinct reacts to stress due to the lack of choices. With the Quads approach of three or more exits, it instead aims at targets versus stop outs.

A stop only gets raised once the first or second target gets hit, and no further stop adjustments need to be made. With this approach, the Quad honors the principle that further price extension assumes more significant retracements. Instead of choosing a mediocre adjustment to somewhere between the entry point and the last target, it allows for a wide retracement but still the possibility for the price to advance to even new highs.

Now the real crux is that stops in themselves are flawed. They assume to know when or where prices do not turn anymore in your favor. They can be based on all sorts of logic and are mainly there to avoid significant losses and stabilize the psyche since human instinct gets hopeful in adversity. Novices typically place stops following their intuition of hope to find themselves in terribly large losing positions or, worse, a string of such losing trades.

The significant shortfall in this business is that there are no small rewards. You can't make a living on trading. Either you acquired the skill necessary, and then you are a casino and make a killing, or you are a consistently losing trader.

Taking this as a premises-once you have an extensive system, with that, we mean one with an excellent risk-reward ratio on minimal risk with a high hit rate, and yes, all of this is needed to compensate for execution errors; stops become more meaningless.

A well-functioning system allows for a few losing trades. Stops on these rare trades, due to the high hit rate, are much easier manageable since the trading psyche of a consistently winning trader is vastly different than the one originating from scarcity feelings.

Trailing stops is an art form that can be easier managed with a pairing out-system approach and are more and more negligible as a problem once strong trading discipline and good execution skills with a solid trading system are established. Or in short, stops are just a problem for those who don't know where entries and exits are to be placed.

The best stop is a target.

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