Stop losses - 2% rule vs. ATR Stop

[andrew_c2o]

Hi All

I'm just starting out in the share game and have read a few books on strategies.

I quite like the 2% stop loss rule and also the ATR stop loss. I know there's no right or wrong stop loss rule, just wondering what people prefer to do here and why. A stop loss based on your equity or another calculated stop loss? Or do you look at both?

Thanks! Great forum!

 

[GreatPig]

Re: Stop losses - 2% rule vs ATR Stop

Andrew,

Not sure what you mean by the 2% "stop-loss" rule. From my understanding, the 2% rule is about choosing position size to limit total losses given a particular stop position. It's not for choosing a stop position.

For example, you'd use ATR alone to determine the initial stop position when purchasing a share, then based on how much loss per share that would amount to if the stop got triggered, you'd use the 2% rule to determine how many shares to buy so that the total loss on hitting the stop wouldn't be more than 2% of your trading capital.

That's how I think the 2% rule works, but of course there may be other 2% rules as well.

Depending on the amount of capital you're using though, 2% can be an awful lot. With larger amounts of capital, 1% or less may be better.

GP

 

[andrew_c2o]

Re: Stop losses - 2% rule vs ATR Stop

Ah yes that would make more sense than having the 2% calculate the stop price. Thanks!

 

[tech/a]

Re: Stop losses - 2% rule vs ATR Stop

GP is talking of "Fixed Fractional Position Sizing"

The 2% rule was adopted by most educators as it was accepted that to wipe out your capital it would take many losing trades to achieve this feat---many however seem to be able to accomplish capital base wipeout easier than turning a consistant profit.

There is a short paper on Stops here https://www.aussiestockforums.com/forums/showthread.php?t=1363

Position sizing and risk strateries will vary often greatly with the instrument being traded and the capital base you are using.
Derivatives different to Shares different to Futures Different to CFD'S etc.

Dont confuse "Initial stops" with "Trailing stops".

I personally use 1.5-.5% as my stop limit on capital.With larger trades Im always trying to maximise my risk reward.To do this it necessitates I take a wider stop at initiation then on the second buy (Usually higher than the first) closing the risk gap and maximising R/R ratio.

The trade Ive posted on ADB will be an example of this if the trade pans out as a profitable one.May be easier to follow there.

https://www.aussiestockforums.com/forums/showthread.php?t=1385&page=2

This is a very lengthy topic and one of my favorites,I intend to add to the discussion thread as situations and examples arise and welcome others inputs,a most important topic.

tech

 

[andrew_c2o]

2% rule

I was thinking about the 2% rule and doing some calculations. Say I had 20,000 to put into the markets so a single trade would allow me to purchase $400 worth of shares. Now this would mean I would need the stock to up by at least 25% minimum to make $100? Now 25% is a big jump for only $100 gain, how's anyone supposed to make money with this 2% rule, it's a good rule if your total trading capital is 100,000 or more but for an average person I would say 20,000 is quite a lot already to put into the markets.

 

[ctp6360]

Re: Stop losses - 2% rule vs ATR Stop

I was thinking the same today. Based on some things I've read I've seen that dividing your capital into 10 different 'lots' so that any given trade even if you lost 100% you would only lose 10% of your capital is a good idea.

However when starting with a small amount like $20,000 you're only talking $2,000 per trade so this eliminates the ability to 'scale in' and it means that brokerage is starting to become a high issue with such small amounts.

I am wondering if when starting with such small amounts of capital it is better to concentrate your funds into, say, 4 lots of $5000 rather than trying to spread it so thin?

I guess this is something I have to experience for myself before I find the right way for me.

 

[andrew_c2o]

I don't think there is a good,bad,better way just depends on how much you want to risk with each, if you want to divide your capital into 5 lots then your giving yourself 5 chances to loose before all your money is gone, can you tolerate that risk? It just depends on your risk tolerance i guess

 

[tech/a]

Re: 2% rule

I was thinking about the 2% rule and doing some calculations. Say I had 20,000 to put into the markets so a single trade would allow me to purchase $400 worth of shares. Now this would mean I would need the stock to up by at least 25% minimum to make $100? Now 25% is a big jump for only $100 gain, how's anyone supposed to make money with this 2% rule, it's a good rule if your total trading capital is 100,000 or more but for an average person I would say 20,000 is quite a lot already to put into the markets.

No this is not correct

2% of your capital is $400.
To calculate how many shares you can buy you must know your risk.
This is called "Fixed Fractional Position sizing"
See chart as an example.
Hope this clears the 2% risk rule up.
If your not clear please ask as protection of capital
is the most important of all you must learn.

When it comes to RISK there are DEFINATELY better ways to handle RISK than Risking whatever you feel comfortable loosing.
Dont be comfortable loosing ANYTHING.

Buy these 2 books.
(1) Risk ---- Mike Lally.ISBN 0 7016 3667 X
(2) The Trading Game---Ryan Jones.ISBN 0-471-31698-9

 

[andrew_c2o]

Re: Stop losses - 2% rule vs ATR Stop

Oh I see now, thanks for clearing this up! So in this case it would worth while doing then.

 

[tech/a]

Re: Stop losses - 2% rule vs ATR Stop

There are a number of ways you can adjust your risk and hence your position size.

The 2% rule is accepted as a conservitive way to trade.Its not the ONLY way.
Personally I have stops which equate to 1% or less/trade.
On larger positions I also ease into a position such as the example on the ABD trade.This further mitigates risk.

You could in the case above decided that you wished to trade 4 $5000 parcels in different trades.
This being the case when you worked out your risk using a 10c risk stop (Found by your analysis) youd have found that it was well above the 2% rule so the trade COULD NOT be taken with that much risk.If you bought $5000 worth!

The maths.

2% of $5k = $100 so thats 1000 shares at $3.80 or $3,800.
To buy $5k worth would place the risk at around 3% so you could either.
(1) Not take the trade.
(2) Decrease the amount of stock you trade to 3800
(3) Decrease your risk by tightening the stop.
(4) Accept the 3% risk.

 

[GreatPig]

Re: Stop losses - 2% rule vs ATR Stop

One thing also worth noting is that there's no guarantee you'll be able to get out at your stop position - even if it's set in the system.

For example, the price may gap down across your stop, or if you only trade end-of-day, by the time you've seen your stop triggered and then put in a sell order the next day, the price could be somewhat lower again.

A couple of good examples of this were shown in this thread on Patrick, where the price gapped across RichKid's stop, and my chart of VPG showing it gapping down across my stop.

Cheers,
GP