Good traders have stop-out points for trades, the point where you’re “wrong.” The aim is to experience a paper-cut. i.e., a minor loss, as opposed to getting your arm chopped off having a trading catastrophe.
A good methodology suggests a clear-cut point where your trade thesis has broken down, you admit you’re wrong and it’s time to move on. Having said that, the market has a certain amount of randomness and “natural vibration.” Some of us at PTL give our trades a little extra “wiggle-room” to account for this. Over time we’ve found this keeps us in trades where we would have normally gotten stopped out, thereby avoiding a loss in exchange for a win where we typically get 2:1 or better on a trade.
Of course, trading records need to prove this is worthwhile so that the periodic extra wins pay for the tradeoff in building in extra room in the trade, and then some. Naturally, there’s no “free lunch.” The tradeoff in doing this takes one of two forms:
To arrive at the wiggle-room amount we start with 10% of the standard daily ATR (dATR). Once we have our basic stop-out point based on the core principle/trading strategies we use, we then add on 10% of the dATR or an adjusted fraction of that. Our rule-of-thumb is that the additional cushion should be no greater than 20-25% of the initial stop-out amount. So if you’ve got a “basic stop” of $0.50 and 10% of the dATR is $0.20, we add on $0.10-0.12 to the trade beyond our core stop, since those amounts are 20-25% of $0.50.
We’ve found this methodology works very well for us and enhances our P&L. To evaluate its potential for what you do, over the course of a month or two, be mindful of the instances when you’re stopped out and determine:
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