- Going over old stuff covered here many times before. In view of recent breach of trading discipline, writing this post is a useful reminder to help myself get back on track.
- Only position in TRENDING markets. Not difficult to decide what trend is when there is one. Stay out of non-trending markets.
- Statistical Hypothesis Testing : Let Null Hypothesis (H0) = Market is Trending.
- Type 1 error = H0 true but reject H0 ie Market Trending but stopped out of Good Position prematurely.
- Type 2 error = H0 false but accept H0 ie Market Non-Trending but holding on to Bad Position for too long.
- For long term trend trader, Type 1 error is far more costly. Avoid Type 1s at expense of making more Type 2s. No free lunch.
- Therefore, only stop out when it is absolutely clear that original technical picture (which got one into trade) has changed. As long as the latter has not occurred, allow oneself maximum degrees of freedom.
- In deciding "change", avoid getting caught up in market frenzy by disregarding time frames of daily and below.
- At point of entry, it will not be clear how and where the (stop out) change will occur. Therefore, trade only in "Small" to compensate. This is not a vague concept but rigidly quantified by risk/money management rules.
- Example : Recent short USD/CAD trade. Could not handle pain of Type 1 error because of wrong sizing. Chart now still down-trending, trade is still good, H0 stands. But I got out pre-maturely. Bad error.
22 June 2011
On Trading Without Stop Losses
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2 comments:
This clarification is great. I especially like your point about not getting caught up in market frenzy on anything below daily charts. I've been struggling with that point and scaling appropriately. Though it is scary to think that things like flash crashes or big volatility can occur and can easily liquidate your account with no stops put on. But I guess you are well capitalized and trade small enough to minimize that issue.
I definitely had a few costly type 2 errors last week, things got ugly when I was on the wrong side of crude consistently.
excellent post ... thanks for sharing your thoughts
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