Why You Should Be Careful With Too Small Stop-Loss

In the past, I met several traders, that experienced live results completely different from their backtest results. The cause was a seeming triviality - too small stop-loss. Let me explain to you today, why this can be a problem, what to be aware of and how to avoid this danger. The following topic is just about those breakout strategies that are using STOP order to open a position and, at the same time, they are using too small stop-loss (this article is not about strategies using market order). What is too small stop-loss? Well, it depends on the market and the timeframe. But in general, it is a stop-loss smaller than the size of an average bar of our main timeframe. Let me give you an example - if we are using a 30-minute chart with an average bar value 250 USD, and our strategy is working with an 80 USD stop-loss, we are heading into a serious trouble. The live trading results might (and in most cases almost probably will) be totally different from those that we have from the backtest. Let's take a look at the reason why.

This problem occurs when the stop-loss is so small, that some of the trades have entry order and stop-loss on the same bar. Let's say we have an entry STOP order on the price 100 and also a stop-loss on the price 99. Now, imagine that the bar opens on 98.7, it goes to 100.1 and we open the long position - and the stop-loss is set up to 99. And all of this happens within the same bar - i.e. within this one bar, the entry order is activated, the position is opened and the stop-loss is set up.

Now it is important to understand why this can be potentially a dangerous problem. It is quite simple. There are several backtesting platforms which are not able to recognize, with the wrong setup or when the data resolution is not fine enough if the stop-loss was or wasn't hit on an entry bar. In other words, there are certain situations when, in reality, the stop-loss was hit right after the position was opened, because right after the activation of the entry order, the market starts heading south. However, our backtesting platform evaluates the trade as a profitable one (from now on I will write about TradeStation as it is a platform that I primarily use). How is it possible?

Let's continue with the demonstration of the situation described above. In this situation we can see the rising bar, i.e. the one that has a close price above open price and, at the same time, the close is close to its high.There is an assumption that the bar was raising the whole time and TradeStation assumes that the "inner" move of the bar, i.e. the way the bar was generated, was constantly rising, a straight line.

TradeStation is simply following the logic that when the bar closed close to its high, the process of generating this bar was rising. In such situation, TradeStation assumes that the bar opened on 98.7 and the price was continuously rising to 100.4. And during this time, it also activated our buy order on the price 100.

Nevertheless, this is very inaccurate and dangerous assumption. What if the bar was first rising, activated our purchase order, but then it reversed and went back down, below our stop-loss, and then started rising again to close to its high?

This is a totally realistic scenario that is happening every single day and that would result in a clear loss (right after we open the position) - and yet, TradeStation (and potentially also other software), defines the situation as if there wasn't any correction inside the bar at all. So no stop-loss was hit and trade ended up as a profitable one. This is the root cause to major problems as in the backtest you clearly see a lot of profitable trades that, in reality, would end up as losses - and right after we start trading this strategy live, everything starts falling apart...

Protection #1

Luckily the situation isn't so serious as it looks like and the backtesting platforms, in general, take this risk into consideration.

The first protection against this threat is simple and, to a certain level, highly efficient. TradeStation calls it LIBB (Look-Inside-Bar-Backtesting), others call it different names, like Bar Magnifier. The point is that when you turn on this feature, the program looks inside the bar to the level of the finest available data resolution (in most cases it is 1 minute), if there wasn't any inside correction after the entry order was activated, or if there was a correction on the same bar when we entered and the stop-loss was hit.

Despite that it sounds like a great solution (which is today a standard part of most platforms), it doesn't have to be sufficient when it comes to small stop-losses. Why? Imagine a situation when your stop-loss is 80 USD, but the average bar of your finest LIBB resolution (i.e. mostly 1 minute) is 150 USD big. In this case you are experiencing the same problem as described above, when the platform is not able to determine whether the stop-loss inside the bar was hit or not and it makes, again, just an inaccurate approximations that are driven by the above-described logic - if the bar closed closer to its low or closer to its high. In other words, you are again at the beginning and with too small stop-loss, not even LIBB will help you, and the problem still persists.

Protection #2

So, we are getting to the point when we need to go a little bit deeper to solve this problem.One of the solutions would be to use even finer data resolution - down to the tick level. But this isn't as easy as it sounds. Firstly the tick data history is not so easily accessible, or just for a very short period. And if these data are available, they are really expensive. But even if you still purchase tick data, you need to solve several technical issues - as the tick data are usually so big, that most of the platforms won't handle so many data, crashes or runs backtests incredibly slow (I can confirm this).

Protection #3

So we need to use much simpler solution - and that is the necessity to use reasonably big stop-loss. And what is reasonably big stop-loss? Simply use stop-loss that is at least 1.5-2x bigger than the biggest 1-minute bar on your chart. It is simple and you can avoid several problems. For example, if the biggest 1-minute bar for all your data history was 300 USD, use stop-loss at least 450 USD. Period.It is simpler and safer to get used to higher stop-losses than lying to ourselves and subsequently be surprised why such a nice backtest equity is quite the opposite of results of live trading.

Happy trading!

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Forex Trading: The Largest Trading Platform

The Forex have advanced from the humblest of beginnings to the world's largest market by dollar volume. With many different entry points, hedgers and speculators can find what they are looking for. Whether they pursue a more complex strategy or simply want to hedge their everyday currency risk, the Foreign Exchange markets provide the liquidity and instruments for trading in currencies.

Hedging simply hedging implies controlling or reducing the risk. It is an investment position that is used to reduce any substantial losses or gains undergone by an individual or an organization. This is done by taking a position in the futures market for limiting risks associated with price changes.

In other words, the hedge is 100% inversely interrelated to the vulnerable asset. A hedge can be built up from different types of financial instruments such as stocks, exchange traded funds, forward contracts, insurance, future contracts and many types of derivative products.

The Power of Risk/Reward and Hedging
Since Forex trading is a risky one, understating the usage of Stop Loss and Take Profit orders is imperative in trading. Stop Loss (SL) and Take Profit (TP) are used for hedging the risk and rewards of the trader for realizing the profits and minimizing the losses.

There are several methods that traders/investors with a lot of money implement in order to reduce the risk of their trade. One of these techniques is called hedging. Hedging is basically making twofold investments, one investment which will make as the main investment and the other, less risky investment supposed to offset any potential losses incurred from the main investment. It involves reducing the risk that one faces while indulging a business deal. In short, hedging is fundamentally a method which secures the future income.

eToro is a social trading App that places an automatic Stop Loss order on all trades so as to prevent the trader from losing more than he has invested. If the rate of his open trade falls below what is covered by his investment, then the trade is closed by the automatic Stop Loss automatically.

By setting a Stop Loss order a trader makes sure that the value of his trade does not drop lower than a certain level. This way the trader control the maximum amount that he is willing to lose on a trade, without having to check each trade throughout the day.

Take Profit orders are also similar to stop loss orders which only meant to profits. TP orders make sure that once the trade reaches a certain level of profit it will be closed.

Effective Money Management in Forex.
In the Forex market, money management or Risk Management is the key factor which should be seen as a positive element. Money Management is a defensive concept which keeps the trader in funds so that he can trade another day and bears outs profitable performance. It is the key factor that is the difference between success and failure. With risk management the trader needs to manage his means to achieve his ends. Sometimes it is absolutely the right thing to do to get a loss so as to avoid making much larger and more catastrophic losses to his hard earned funds.

For a trader, the proper usage of trading plan is very important that lays out strategies for the trading activities. Helping traders to manage their money and the risk exposure are the practical uses of such plan. The plan should comprise details of what risk level the trader comfortable with, and the amount of capital he has to use.

A trader should really adhere to the levels of risk that he draws in his plan. If he desires to make low risk trades, then there is no reason why he should start exposing himself to higher levels of risk. It is often tempting to do this, probably because the he has made a few losses and he wants to try and fix them, or maybe he has done well with some low risk trades and want to start increasing his profits at a faster rate.

The risk management and the wealth management are to be exercised with a proper strategy, then most possibly there are high chances for getting good profit. A good quality money management strategy helps the trader to survive a losing streak. To do that, it needs to be flexible. A trader should not invest a fixed amount per trade, but a fixed percentage of his starting balance.

Remember, money management is very simple to exercise, but not as simple to carry on. Once the trader developed the money management system that works for his trade, make sure to stick with it and do not let his emotions get in the way of long term profit, although it means absorbing short-term losses.

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Trading Trilogy-3: Money Management

30 feet-the old Kilo Class submarine dives deeper onwards to 100 feet-200 feet-400 feet-600 feet-800 feet-an explosion occurs, maybe the batteries were faulty? The submariner notices the creaking sound of the extremely high pressure of water against the submarine hull. Water rushes in. 

Automatically the high-tech systems of the submarine seal the flooded chamber. Luckily the engine room is intact, and the submarine painfully tries to resurface from the depths of the Pacific Ocean. The remaining compartments are dry, and the incumbents are safe.

You must be wondering whether this is a prelude to a thriller short story, or an article on money management, in trading. This had to be made dramatic because your money, that is, your capital is like blood in your body. Your body needs blood to survive; in the trading scenario, your account needs money for you to survive in trading, so treat it very carefully, like a mother lioness takes care of her cubs, without letting go for a moment.

Like a submarine, you've got to divide your capital into equal compartments, or parts, so that if one compartment gets flooded, that is, if one trade goes bad, your chances of recovery will be good. Remember, however good you or your method may be, the markets are not always conducive to trading.

 If you get shortchanged multiple times in a short period, step back, analyse whether the problem is with you, and your method, or the markets in general. If it is with you, course correct, trade with smaller amounts till you get the confidence back, or stay out till you get in sync with the markets. If the markets are finicky, and non-tradeable, stay out till some semblance of sanity returns, then re-enter.

Do not trade without stop-losses;most experts advocate putting them in the system, some traders write them on paper, and execute the trades manually. Do not keep a position open, if accessibility to the trading terminal is an issue.

It's your take, what methodology you would like to follow. Keep the stop-loss to not more than 5% on every trade;when your account size grows, limit it to 1% to 2%. You have to live to trade another day. Trade with the amount you are comfortable with;do not try to emulate others. It has been noted that when one crosses one's personal threshold, the subconscious mind tries to sabotage the effort, because it is uncomfortable with larger than normal amounts allocated to trading. The Peter Principle comes into play, that is, the person rises to the level of his/her incompetence. If it so happens, cut down on the account size, and trade similar sizes till you get into the flow.

Always keep a record of the amount left after every trade. It is a barometer as to how you are doing as a trader. Ignore this at your own peril. A rising equity curve suggests that you are on the right track to becoming a successful trader. Remember, money flow in trading equals blood flow in the human body. Your survival as a trader finally depends on it, and is not to be taken lightly.

Article Source: http://EzineArticles.com/9576355

Trading Binary Options Is not Easy as it sound

Many people attribute binary options trading as a betting of sorts because a trader has to trade only between two variables; the rise or the fall of a certain market or Forex. For some, however, this is an easy way of trading and often yields in substantial profits for traders. But no matter how simple it may look like, binary options trading is not for beginners and definitely will not work for people with zero experience with index trading. This is where Mark Tencaten and his team of professional market analysis experts come into the picture.

Mark's team created an effective strategy to significantly win in binary options trading. By instituting a combination of variable trading timeframes and using market alerts that help traders put in the right trades, create a high probability of winning. The market alerts are basically predictions of whether a particular market or Forex is rising or falling for a given period. When the prediction of a market or Forex is to fall for a certain period, trading in that direction will result in a win if the market indeed falls within that certain period. These predictions are based on expert analysis of market experts around the world. To maximize profits, the team also trades on different foreign exchanges as another strategy. So within the day, there will be more than 10 trades per day getting traders the most out of the usual trading results.

An interview with Mark Tencaten gave us an overview of how he managed to win with binary options trading and what his ideas regarding its future in the index trading world.

We asked about his views on the current issues surrounding binary options trading and how to deal with the fake traders. His views circles around regulations. Binary Options is a legitimate trading and there is a small number of companies that engage unacceptable practices that somehow affects the image of the industry negatively. He pointed to some operations in Israel that lures people into engaging with certain brokers, getting their money and eventually leaving. These kinds of practices do not necessarily reflect the reality about binary options trading.

"I am a little bit appalled knowing that a small number of illegal companies that lured people into investing in binary made a huge negative connotation to the industry. I think the problem here was more on the regulation pertaining to the operation of these fake companies rather than the industry as a whole. Otherwise, if we single out binary options, then it is better that we also include other markets trading," Tencaten wrote in an email.

He reiterated that binary options trading is not for newbies. Skills are needed to win in this and it would also require a self-assessment of the level of risk the traders can trade. Additionally, the market alerts are there as a guide but cannot be solely depended upon. Traders, especially the self-managed ones, should be able to learn and know how the commodities they are trading on behave within the market and at a given period.

Lastly, a good exit strategy will shield a trader from losing so much. Normally, trades can start at the minimum of 10% of the value the traders' total daily trading money. This limit serves as a safeguard during the trading day and also guarantees of multiple trades within the day. They should also mind the Stop Loss - Stop Profit percentages as this will help them with automatically end trading once the set percentages are met.

In the end, the success of traders in binary options really depend on several factors. But if you get yourself abreast of the techniques and keep yourself connected with people such as Mark's team, you will get to have more edge over everyone else.

Article Source: http://EzineArticles.com/9681273