Over the Hedge: A Horror Story for traders

For most traders the idea of hedging to manage risk and money when trading is a horror story waiting to happen. "What no stop loss...why is he doing that, he is going to get himself killed". This is what traders would shout out at the television, while watching someone trade this way.

So is trading with a stop loss necessary, for most traders the answer is, YES it is but that is because they were taught to trade that way. In this blog I'm going to explore the reasons why most traders trade using a stop loss and why traders like me think it’s all propaganda.

When starting my trading career I was taught that which most of us were..."never, ever, ever, ever trade without a stop loss" and that is just what I did...I always traded with a stop. The thing that got me was that even though I followed what the majority was saying by using a stop loss, I still managed to lose more money than I made. The thing about trading with a stop was where to place it, some said at the lowest low or highest high, others says a tight stop is best (never did get that one) and other traders went with a stop related to the take profit, so if the TP is 30, they would make the SL 10 to have a 1/3 risk reward ratio.

Believe me when I say that I tried everything under the sun but always found that the stop got hit by 2 ticks before the market went my direction, or the stop is too tight and the volatility of the market stopped me out all the time. I realized the market never retraced the same distance so where to place a stop loss really did not mean anything.

I decided to take a lesson from Warren Buffet who said that when the majority sells, he would buy. Like the guru of investment, I too decided to leave the majority behind and go with no stop loss. By doing this and looking at trading differently, a couple of key aspects jump out at me.

One: it’s easy for traders to take profit but not many know how to manage their trades when in loss. The mighty stop loss is the management tool they were given to challenge the potential loss but all it does is take money from them.

The first step to overcome this challenge was realizing that trading with risk factors of 10% , 5% or even 2% (as so many traders do and promote others to do) is not a good idea at all and so all my trades had a risk of only 1%. This helped with my psychology because now a trade would have to go negative by 100 points before the full 1% risk is realized.

Step two is keeping the trade open while in retracement. Most times trades don't retrace more than 100 points before they resume the trend, helping us to take profit instead of giving away money on the stop loss.

Thirdly, knowing what to do when the market gives you an indication that there’s a potential swing (this means that the market could turn) and so when I get this indication, I hedge the position. This basically means that I enter a trade in the opposite direction with the same risk. The positions get locked in, so that that no matter how far it moves up or down the traded loss remains the same.

Lastly, once the market gives me a clear indication of the direction, whether short or long, I enter a trade in the direction of the confirmed direction and I close the trade that is against the confirmed direction. I now have two trades edging towards profit with every tick that they move.

This idea of hedging means that I was able to manage my losing trade without placing a stop at a level that I myself don’t know will be effective to manage any losing trade. It also ensures that when the market is ready to reveal its intention around the direction, I would just have to gain half of the pips I lost on the trade I closed to break even.

The thing is, if trading with a stop is the best way to trade, then why are more people not successful when trading forex. Whilst writing this blog I had a trade to long on the GBPJPY and the pair was down 28 pips which was only 0.28% risk (very small amount based on the 1% risk). If my stop was tight then I would have been out but instead the market went long again and I am up 16.7 points.

Realize one thing today, you have not been given rules to keep you safe when trading but instead, you have rules that allows the big players to take one stop at a time in order that you stay in the game and they can take more from you tomorrow.

There is no rule book that says you must use a stop OR ELSE...give it try...you have nothing to lose, not even your stop loss. Contact me if you would like to find out more about how to trade without a stop.

Eugene Herrendoerfer