Wednesday, September 24, 2014

STOPS and their impact on your bottom line.

In one of my regular webinars we discuss how to determine a strategy for trading.

In the webinars we discuss how to find a strategy that works well considering the variables that will be at play for them.  Different traders have different risk tolerances, differing abilities to sustain open position draw downs, and differing amount of time available to trades.  MetaStock has one of the best collections of available systems for customers looking to find a strategy that works for you.

What a lot of new customers do not realize is that it is very easy to customize the built in Systems to test different stop strategies.  What's more important is to be able to quantify the effect using stops.

To illustrate this, lets take a look at the Pattern Trading System in MetaStock.  Performing a system test in MetaStock over the last year of trading on this system would yield the following equity curve.

This is a pretty good equity curve.

So it is definitely a system I would consider trading.

Looking at the chart and commentary in the software, it specifically states

"While [This System] can be very good at capturing profits on a large number of trades, no real protection mechanism has been put into place if the trade immediately moves against you. Stop-loss orders should be used to prevent the few failing trades from removing all acquired profits."

So, it might be a good assumption to take Apple and take the next available signal on the stock.  How do we decide on what stop is going to work for us.  If we place our stops too close to the current price, we get whip sawed out of the market during normal market maneuvers.   If we place our stocks to far from price activity, then we are taking more of a loss than we need to.  As a trader, I want to know what impact adding a stock is going to have to my overall performance on that security.

Luckily, with MetaStock its very easy to add a Stop to any system, whether it is only of the 40 in MetaStock or one you've created.  To do this open up your Power Console and go to the system you want to change.  From here click on the Stops tab.

From here you can add trailing, inactivity, maximum loss, and breakeven stops.  You can also test your strategies with a Profit Target if you'd like.  

Adding a 5 pt stop loss to the system test with Apple, provides a much different equity curve:

Here's a comparison with a 1 Percent stop loss.  

I actually thought 1% would be to tight of a stop before I tested it.  In the historical test it actually outperformed the 5% stop by almost 3% over our test period.  

On a final Note, if you are adding any type of Stop to your trading plan--Test it before you add it.s and the results of the stop will most likely surprise you.  

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