In emphasizing the issue of stop loss in trading, one could say that our trading skills gradually improve over time as we learn how to execute stop losses correctly. The importance of stop loss in trading means it should never be optional, but rather a question of how to do it scientifically. Today, let's talk about this subject briefly.
All aspects of trading—philosophy, ideas, planning, execution, and strategies like stop loss and take profit—are never independent problems. Each element is intricately connected. We see some traders excel at risk control, while others are good at entry points. However, when all aspects can't connect properly, it reflects issues on the equity curve, ultimately resulting in an inability to achieve a stable trading state.
Therefore, stop loss is not an isolated issue but closely related to the entry system. Many beginners simply think of stop loss as merely setting a stop at the entry point to control losses and thus achieve risk control. In my opinion, scientific stop loss must meet three conditions:
1. Align with your own risk control model
2. Match your entry model; stop loss methods must align with entry models
3. Conform to your mindset and philosophy
How to understand this? Many people only meet the risk control model, which is often referred to as the proportion of funds lost per trade. This is a correct thought. However, if the stop loss only satisfies the risk control model without considering the model, strategy, and philosophy, it remains superficial. This is why many still experience losses despite strict stop-loss measures. Losing 2% or 3% per trade is not the key to profit but the basic risk control model. Stop loss must meet more than just one condition of risk control. You must be clear about this.
Next, let's discuss what stop loss is. Firstly, we need to understand the best entry point for going long, which is the lowest point, but no one can enter at the lowest point. We can only enter at a relatively low point, and the difference between the lowest point and the relatively low point is the cost we must pay in trading, which is the stop loss. This is the fundamental explanation of stop loss. Many don't understand what stop loss is, either setting a large stop loss that slowly kills them with heavy positions or a small stop loss that bleeds them to death.
However, many investors' stop losses cannot be called effective stop losses. What is an effective stop loss? It has two meanings:
1. As per my explanation above, many people don't dare to set a relatively large stop loss due to heavy positions and often see the market move in their trading direction post stop loss. This shows the relationship between stop loss and position size. On the whole, one should be accustomed to light positions with relatively large stop losses, not heavy positions with smaller stop losses. Stop loss should always be a range concept, a trend-following concept, but never a single-point concept. Use a more universally applicable method, so you can navigate bull and bear markets and cycles.
2. Adapt to the model stop loss, which is a model problem. Different stop loss methods match different entry methods. When your entry methods differ and the model is chaotic, the stop loss will naturally be chaotic. From a person's order method, stop loss method, and profit and loss distribution, one can determine their trading model and level. Once the model is determined, the stop loss is a definite concept—in short, scientific. Otherwise, such stop loss methods are not advisable.
The certainty and scientific nature of stop loss are just appearances. The essence is the consistency and modeling of entries, which ultimately create stop loss consistency. Therefore, discussing how to stop loss is secondary. The primary discussion should be about the entry model. Your entry model determines the market conditions you aim to trade.
Define what kind of market you want to trade, such as trading daily swings. Essentially, this means you are probing the highs and lows of daily trends. Our entry points aim to create potential daily highs or lows during the current trend reversal formation. Two critical issues must be understood:
1. The standard for current trend reversals, i.e., the certainty of our buy points, commonly known as quantification. This is the consistent buy point.
2. The frequency of trial and error. These two factors constitute the basic trading rules. Many only focus on buy points, designing them and strategizing, without considering the trial and error frequency. This major issue means that although signals may not be problematic, everyone executes well when things go smoothly. The critical issue is handling when things don't go well. The root issue is the frequency of trial and error. Using 5-minute and 15-minute charts for daily swing trial and error frequency fundamentally differs. The trial and error frequency of entries must meet your own tolerance for losses.
Once these issues are clear, your entry points become clear. When your entry points are clear, the stop loss naturally follows. Consistent execution over the long term leads to consistency and power. In the face of other market participants, you become the reaper.
Many people always say that my explanations are either redundant or that I've explained everything clearly. Indeed, I've clarified everything. Most people either want to hear about the holy grail or don't yet have the market comprehension to understand my words. If you don't grasp it, save the article and review it multiple times when you have time. Trust me, if it's meant to be, you'll discover something new.
The stop loss method discussed above applies to right-side trading. The principle of stop loss lies in the breakthrough of the current trend, driving the formation of buying points, making the lowest point our effective stop loss. This is the basic stop loss method. However, the effectiveness of stop loss is not solely determined by the buying point itself but also by our positioning, strategy, mindset, etc. When constructing a buying point, don't forget the type of market you aim to achieve the final profit from. This is the core idea. That's why there is no holy grail in this market, nor any absolute method. But you can certainly find a method that suits you.
For left-side trading, which is a trend-following trading method, it involves another stop loss method. The stop loss criteria are based on trend conditions. The stop loss depends on whether the daily trend still exists. If it exists, there is no need for a stop loss. Therefore, for this method, the stop loss is outside of trend conditions. Any pullback in a confirmed trend becomes an entry opportunity, depending on whether the stop loss is reasonable.
For example, if the major trend AB is established, any low point from the start of the pullback from point B becomes a buying opportunity. Whether to buy depends on whether the stop loss is reasonable and the cost-effectiveness is appropriate. The concept of pullback implies that the price will rise by the amount it falls. This represents our basic cost-effectiveness. When the price starts to pull back, the stop loss location dictated by trend conditions and our observable space constitutes the basic reference for entry. That's why the core of trend-following lies in buying during trend pullbacks, but exactly when to buy is not crucial.
Many think it's important because they always want to find the exact point. Long-term, this is futile. When following the main trend, what you need is reasonable cost-effectiveness. Many claim that the stop loss in such cases would be large. Indeed, stop loss for trend-following is relatively larger. To profit from the daily trend or the large trend movements it drives, having a slightly larger stop loss is quite normal. Always aiming for the smallest stop loss to capture the largest move leads to the most painful experience and the unattainable holy grail.
To summarize, the first stop loss method is a model-based stop loss. It derives from a mature model with a definite buying point based on current trend reversal. This needs you to establish a basic standard, which is straightforward. The core is to be unambiguous. This way, it won't spiral out of control and morph. Deeply understand your model, and you'll find your stop loss method. The second method is stop loss in actual daily trend trading. With trend conditions as the stop loss, so long as the trend doesn't change, stop loss is at a definite point on the daily turning point. This method's implied market differs, and cost-effectiveness means the market must return to a point that triggers your trading desire. This bears a resemblance to subjective trading. Traders with over a decade of experience understand what I mean.
Another more profound point is to grasp that subjectively tracking daily trends aims to categorize markets to form a basic model for profitable scaling. Our course hasn't reached this part yet, but I will delve into it in the future. Here, I just introduce this concept. Why start with market categorization? Because only by fully understanding all basic market types can we break them down further. For most, understanding the first entry and stop loss modes is enough to outperform the majority. The subjective trend profitable scaling model follows after the initial mode as experience and understanding of the market grow. Trading is like leveling up in a game—doing what matches your level is vital.
Regarding taking profit, there's little to say. In trend following, the exit is not that important. There are two profit-taking modes: active and passive. The course has covered both. Combining these with the position development stage allows for adjustment. To me, whether you exit well is not a big issue. Reflect on what I've discussed before; it solves the exit question well.
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