TGIFF #007: WHY WIDER STOP LOSSES ARE YOUR FRIEND

I have been getting quite a few messages from people (not clients) who tell me they have a strategy that is initially working for them, that the trade is working out in their favor, but they continually keep on getting stopped out of their trades.

So, I thought I would write this article to help you navigate this piece of your trading puzzle. 

For some reason a lot of traders really struggle with stop loss placement – when in fact, it is the most important aspect of trading.

So, before we dive in, if you are struggling with correct stop loss placement, the obvious thing to do is STOP trading until you read this article.

As my subscribers know, I’m a huge advocate of having wide stop losses.

Many, many, traders are tempted to place a tight stop loss on their trades.

There are lots of reasons for this, however the main reason is they simply do not understand position sizing, risk to reward ratios and probably at its core GREED. 

Many traders fall into the trap of having a tighter stop loss placement so they can trade a larger lot size. If this is you, I have news for you, and you are probably not going to like it…. 

YOU WILL EVENTUALLY GO BROKE. 

That is to say you will blow up your account, it’s not if…it’s when.

So, let's sort that out.

Lot sizes and how it relates to your stop loss placement. 

Many novice traders think in lot sizes.

Let’s say you have a small trading account ($1000.00) and you decide you are going to trade 1 mini lot $1.00 per pip (0.10).

Because many traders only think in lot sizes, they think using a wider stop loss increases the amount of money they could potentially lose. 

Conversely, they think the smaller the stop loss reduces their risk. 

This is simply not true.

A trader with a $1000.00 trading account who decides to trade 1 mini lot wouldn’t dream of having a 100 pip stop loss because they are risking $100.00 or 10% of their trading capital. 

So, what do they do?  

They have a smaller (tighter) stop loss to reduce their exposure!

This is because they do not understand lot sizes in relation to stop loss placement.

It is the lot size that determines your risk per trade NOT the positioning of your stop loss. 

Let me repeat this - it is the LOT size that determines your risk not the position of your stop loss.

SO, WHAT DO YOU DO?

The risk amount (lot size) you are trading is adjusted up or down DEPENDING on your stop loss placement. 

So, the wider the stop loss the smaller the lot size, the shorter the stop loss the greater the lot size. 

Here is the process in order:

1. Determine an amount you are prepared to lose.
2. Then you determine where you stop loss is.
3. Then you adjust your lot size based upon how much you are prepared to lose and your stop loss placement.
4. The easiest way to determine the correct lot size based upon the above criteria is to simply download a lot size calculator. 

Just google lot size calculator. There are hundreds available (just find one that works for you).

So, the wider the stop loss the smaller your lot size and vice versa. 

The lot size calculator will spit out the correct lot size based upon the variables you input (being risk amount and stop loss placement).

If you are adjusting your stop loss and NOT adjusting your lot size accordingly, you are making a grave mistake.

It’s also important to note that wider stops do not decrease your risk/reward, as risk reward is relative. 

If you have a wider stop you will need a wider target / reward. You can still yield great trades around 2 to 1 and 3 to 1 with wider stops.

WHY SHOULD YOU HAVE A WIDER STOP?

You need to give the market room to breathe.

The market must inhale and exhale.

How many times have you been in a trade and it’s going your way, but somehow you lose money (we have all done it), and it is a very frustrating experience. Most of the time this happens because your stop loss was too tight.

Markets move erratically at times without any notice, you must expect the unexpected. 

Because the market can fluctuate wildly and you never know what it is going to do, you need to factor this in when deciding where to place your stop loss. 

I know many traders who simply place their stop loss at a set number of pips and hope for the best.

You cannot just place your stop loss at a set distance on every trade and expect to win. You need to have a strategy.

You need to allow space for the normal daily fluctuations of the market.

WIDER STOPS ALLOW YOUR TRADE TO PLAY OUT LONGER

If you see a setup and it offers you the opportunity of a 200-pip gain, it makes no sense to have a stop loss at say 40 pips. 

You will probably get stopped out. You are simply not going to catch that move before being stopped out.

The goal is to stay in the market until it clearly proves you wrong, not to get taken out simply by the natural daily fluctuations of price.

YOU MUST GIVE THE MARKET ROOM TO BREATH.

IF YOU TRADE THE HIGHER TIME FRAMES YOU NEED WIDER STOPS

My subscribers and I are predominately swing traders (for very good reason) who trade the higher time frames.

It’s no secret that day traders use very tight stop losses, and the simple fact is over the long-term day traders do worse than long term position traders.

Now I know at this point what all you day traders are going to say; however, the long-term results speak for themselves.

It’s a simple truth that people who use tighter stop losses lose more money than those who use wider stops and stay in their trades longer.

This is because day traders use tight stops and are trading the natural “noise” of the market, it’s no wonder they get taken out a lot, they simply do not allow the market to do what it does (fluctuate).

 Longer term trades (higher time frames) need wider stop losses. 

 Let's say you know a pair moves on average 200 pips per week, and you see a setup that offers 200-300 pip profit. 

 It stands to reason you need a wider stop to stay in the trade and let it play out. 

 Yes, trades take longer for trades to play out on the higher time frames, but you get more accurate signals, and it is much easier to see what the market is doing.

WHY DO MOST TRADERS FAIL OVER THE LONG RUN?

The answer is obvious, they lose too much money.

WHY do they lose too much money? There are only three main reasons:

1. They are trading to big a lot size (relative to their account size)
2. They are trading too much (over trading)
3. They are using tight stop losses and not giving the trade room to play out.

It stands to reason the tighter the stop loss the more you are going to get stopped out. 

 Yet there would be countless traders who are great at determining the future direction of the market who can identify a perfectly good high probability setup and then go and place a small stop loss, this is because they either don’t understand lot sizing or are just greedy. 

 Either way it doesn’t end well.

SO BE A SMART TRADER

Don’t become a statistic, be willing to have wider stops and be patient. If that means it takes weeks for your trade to play out, then so be it.

Would you prefer to take 10 trades with a tight stop loss and lose most of them or take 2 trades with a wide stop loss winning big on one of them and losing your predetermined risk amount on the other. 

I can assure you it’s the latter that will keep you in the game and keep you profitable.

If you are struggling with your stop loss placement, if you are not sure about the correct lot sizing, if you don’t understand the power of risk/reward or the immense power trading the higher time frames then I invite you to join myself and my community of like minded traders.

Hope these tactical trading tips are proving helpful for you. I’ll see you next Friday.

Till then, keep trading and have a wonderful weekend!

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