Protecting Your Trading Positions, Part 1
As we discussed in the analysis portion of the Daily Battle Plan, the market is acting the way previous bear to bull markets have acted going all the way back to 1981. The Model Portfolio in the Daily Battle Plan has been successful this year with 13 out of the 14 ETF signals being profitable. All the signals have been on the short side, and even as the market has rallied, the short signals have still been profitable. Why is this? Because the market is still under the 200-day and historically and statistically this has been the the most successful indicator to guide traders on how they should look at the market each day.
Eventually though all bear markets move to bull markets, so how do you protect yourself when this happens? Meaning, what do you do when you’re short and the market has a major rally higher.
The Main Street answer is to use stops. Use stops on every trade is the mantra (it was my mantra too until I saw the statistics a number of years ago). Stops are a form of insurance. If they work for you, keep using them. But, if you look at nearly every mean reverting trading strategy (buying pullbacks and selling into strength…vice versa for shorts) you will see a significant drop in the test performance with stops. Stops are expensive.
Why?
Two reasons.
They whip you around. How many times have you correctly predicted the direction of the trade, put your position on, then get stopped out, and then watch the trade move in the direction you correctly predicted. It hurts. And it happens to thousands of traders every single trading day.
Stops do nothing to protect you from overnight risk. A stock is trading at 30. You believe you’re risking only 10% on the trade with a stop at 27. After the close the company announces negative news. It opens at 15. What did the stop do for you? Nothing. The loss is 50% with or without the stop.
Again, if stops work for you, continue to use them. But the statistics show overwhelmingly that they are an expensive form of insurance which doesn’t insure you 17 1/2 hours of the day (you can learn more about this in my most recent book, Short Term Trading Strategies That Work.
All insurance costs money and the question is which insurance possibly cost less and especially do a better job of protecting you from the craziness of what can happen to a security overnight?
Tomorrow and Monday we’ll look at some solutions.
This is from Larry Connors Daily Battle Plan which he publishes each morning. If you’d like to take a free trial click here, or call 1-888-484-8220 ext 1 to start your free trial today.
Larry Connors is CEO and Founder of TradingMarkets.com and Connors Research.
For more trading strategies, go to TradingMarkets.com/reports.