Dangerous Trading or Opportunity?
The use of very large or no stop losses to create a high percentage of winners
When you become involved in Forex trading and start to learn the secrets of how to become a successful and profitable trader there are a couple of rules that are being taught as if it is gospel – and if not followed could spell disaster. One of the most important rules that are taught by everyone in Forex training or mentorship is the following:
DO NOT TRADE WITHOUT A STOP LOSS!
This rule is self explanatory and makes a lot of common sense. It is part of good money management.
This brings me to another practice that is very common among traders, Signal Providers or developers of automated systems, and that is to bypass the Stop Loss rule by entering a very large Stop Loss. The ratio between Stop Loss and Take Profit can be as large as 100:1 or more.
If one investigates this matter further you arrive at a very surprising finding. The most successful traders with the most followers and the most equity that they manage and who are occupying the number one and two spots at most Signal Providers do NOT use any Stop Losses or use VERY large Stop Losses.
When the number one Signal Provider at of the largest signal providing organization in the world was asked why he does not use Stop Losses, he replied that he managed large draw downs manually and will not change a strategy (no Stop Loss) that has been working for years.
The number one Signal Provider at of a broker service that claims to have the biggest social group of signal providers in the world claims a 100% win ratio, and he also uses VERY large Stop Losses of sometimes as high as 1000 pips and a low profit per trade. Here is his profit history and a typical trade:
Source: www.eToro.com
Stop Loss = 1.3850 - 1.2889 = 916 pips
(This particular trade was already open for nearly two months at that time, while the Signal Provider waits for the market to turn his way)
If one investigates further into the leading automated systems and robots in the world you will find the same is also true for them – mostly scalping systems with very large or no Stop Losses and small profit targets. You can lose three months of profit in one loss trade! I know – it has happened to me.
So what is going on? This does not make sense!
Well, the first thing that you must be aware of is that my references are dealing with contestants in trading competitions, Signal Providers that want to impress possible clients with a close to 100% win ratio so that they can get more followers, developers of automated systems that want to sell more of their robots, etc.
But why are they so successful and show such excellent returns? You must understand that there is a relationship between Profit and Risk – the higher the Profit the higher also the Risk. Systems that have high win ratios normally also have large draw downs, long transaction durations and large losses from time to time that can wipe out many months of profits in one go.
Look at this extremely profitable trader’s performance (over a 3000% return in one month!! - month of Feb has just started):
And this one:
When people see these figures their eyes lit up - tripling your account equity in three months! Greed starts to creep in and visions of a luxury life, which they have always dreamed about, appear. This fever can overcome all fears and caution. But wait….
His maximum draw down is 94.32%!
And look what the calculated Risk is:
(Source: www.FXStat.com)
So the risk of losing all your money with this system is extremely high! 96%!
And, Yes! You have guessed right. He is a scalper using NO Stop Losses!
But traders following this high risk strategy often have the best performance figures and the most satisfied followers / customers. The number one trader at one of the largest Signal Provider services who applies NO Stop Losses with small Profit Targets and up to 700+ pips draw downs, has 12,592 followers and manages over $21 million in equity! His top follower has made a profit of 4,124 pips this past year. One trader at another Signal Provider using +- 1000 pips Stop Losses has 20,587 followers of which 3,252 copies his trades automatically. He is showing a 145% profit over the past 6 months.
So is there perhaps a way to profit from these high risk systems and make good profits with acceptable risk?
The first thing to realize is that the percentage win ratio by itself is not a reliable guideline for making a profit. Let us take for example a system with 96% win ratio with a Stop Loss of 1000 pips, a Profit Take of 15 pips, a lot size of one standard lot, and a maximum of only one trade open at a time.
If you have 1 maximum loss in 100 trades and 3 of average losses of say 200 pips your total loss will amount to 1600 pips = $16,000. Your winnings will be 96 trades of 15 pips each giving you a 1,440 pips = $14,400 gross profit. This gives you a net loss of $1,600. So in spite of having a win ratio of 96% you can still be in danger of a net loss. Furthermore, the higher the win ratio is the more risk there normally is in the strategy.
So we will have to look wider for dependable guidelines to profit from these high risk – high profit systems.
The first priority is to ensure that your account will be able to cater for the high draw downs and losses that can be expected. There are two ways to do this:
- - Have a large enough equity in your account to be able to survive all possible draw downs and losses without a margin call to close the account – often at the worst position – and leave enough equity to sustain your original position sizing for recovery purposes.
- - Use small position sizing, that can be lot sizes consisting of mini or micro lots, to limit your exposure per transaction in order to withstand any draw down and series of losses.
But when you are reasonably safe from most foreseeable draw downs and losses you find that your return on investment (ROI) has dropped to a low percentage and the high %profits that you expected to make, requires too high an investment or otherwise very low profits per transaction. Suddenly you realize that with limited equity you can have the same ROI with a system with a much lower win ratio, but also has a much lower draw down and smaller Stop Losses, and therefore much less risk.
So you must ask yourself the question, is it worth the stress and the danger of large draw downs and possible huge losses in order to make the same ROI that could be made with a much safer trading strategy?
So – perhaps the rule of having a Stop Loss makes sense after all!
In my next article I will continue to look at this issue and then propose a business and scientific way of approaching Forex trading that reduces risk to a minimum, but at the same time nearly guarantees a profitable outcome to Forex Trading.