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I think that Alex's last post gets to the heart of the matter. Sensible
stops are not mechanical items or rules of thumb to simply apply
everywhere on an indiscriminate basis.
FIRST, I only want to be stopped out when an adverse price movement
proves to me that the assumptions which determined my systems original
entry are no longer valid. i.e.. When the current price screams at me
"you were wrong."
How much of a movement that will be is a function of my system. If I've
developed the system, and if I've reviewed every signal that it
produced, and the variety of events which then occurred after the
original entry signal, I should have a very good idea of what to expect
in the form and size of any "noise" after entry.
Stops should be set where the subsequent price moves tell you "this
price isn't included in my systems definition of noise."
Not easy to define, but then it's my capital at risk, and so the effort
should be worthwhile.
But the SECOND part is what's critical, and that's where many of the
2%rs use the right idea the wrong way.
Limiting losses to a % of risk capital is a reasonable idea, for it
forces you to have a fairly long string of losses before you succumb.
But the point that is seldom mentioned is that the actual dollar value
of the "noise" you defined above is the dollar amount you are risking on
that trade. I other words if a decline of $3,000 is your systems
"noise" level trading the vehicle you are investing in, and 2% is the
amount of capital you're willing to risk on a single trade your risk
bundle better be $150,000.
At least that's how I see it. Improvements always welcome.
Richard Funkhouser
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