Trading without a stop loss is probably among the most discussed topics among amateur traders. But often they don’t fully understand the implications of trading without a stop loss and how not having a stop loss influences their trading and the growth potential of their trading.
The following 4 points highlight the problems that will occur if you are trading without a stop loss.
1. You can’t control your position size
If you do not place a stop loss and don’t know where you want to get out, you cannot calculate your position size. Although you may vary the amount of contracts you buy, it is impossible to know what you are actually risking if you do not define a stop loss.
The Edgewonk trading journal does not ask you for the amount of contracts for an individual trade because calculating position size is much more accurate if you know your stop loss price. This point by itself shows why it’s so important to set your stops.
As a trader you are in the business of managing risk and without a stop loss, you can’t measure your risk.
2. No reward:risk ratio
The reward:risk ratio is a very underrated and misunderstood figure in trading. Trades with a small reward:risk ratio should be avoided if your winrate is not large enough. Without a stop loss, there is no way of determining the reward:risk ratio of a trade and and, thus, there is no way of knowing whether the trade you are about to enter will provide a positive expectancy.
Edgewonk comes with a number of reward:risk metrics because we understand the importance this figure has for traders. By knowing the reward:risk ratio you can take out the guesswork and only take those trades that have a positive expected outcome. Without a stop, you are missing out on all the benefits of this metric.
3. You cannot measure trade management
Analyzing how your stop loss changed during the duration of your trade provides insights about your trading, you cannot get any other way.
By comparing the initial stop loss position and the final outcome of your trade, Edgewonk can analyze exactly how well you are managing your trades. Often Edgewonk will find weaknesses in your trade management, point out ways in which you are giving away money or leaving money on the table. A trader who does not have a stop loss is doomed to trade without knowing how to improve his trade management.
4. Knowing which stop placement doesn’t work
When it comes to stop placement (or exiting trades) a trader can choose from a wide variety of options; placing a stop above/below highs and lows, using a moving average, trailing a stop loss or using a fixed stop are just a few examples. And even if you are not using a stop, you have to determine how you exit your trades.
The trader who uses a hard stop has a major advantage; he can very accurately analyze the performance of his stop loss approach and then make adjustments based on his findings. If your stop placement is all over the place and you have no consistency in exiting trades, making improvements is impossible.
The Edgewonk metrics are designed to provide actionable insights about how your stop placement is really working for you and how to adjust your strategy to potentially increase your performance. Again, a trader who does not use stops, will miss out and making improvements will be almost impossible.
Protecting your capital should be your #1 priority
Almost everyone gets into trading because they want to make a lot of money. No one thinks about the risks. Then they go broke. Especially for beginners, their job is to protect their capital as effectively as possible in order to stay long enough in the game to eventually become a break even trader, and ultimately a profitable trader. Reasonable stops and risk levels will keep you in the business for a long time to come and help you improve your trading on so many levels. Don’t neglect them.
*The points made in this article are tailored to spot trading, mainly for forex, futures, stocks, spread betting and CFD trading. Other asset classes such as options trading are based on different premises.