Stop losses and the illusion of safety
Drachten is a small town in Holland, but what’s got to do with stop losses & risk?
Well, a few years ago almost all traffic lights and signs were removed from the town’s centre in an effort to improve traffic safety. This was based on the theory that drivers pay more attention to their surroundings when they cannot rely on strict traffic rules. What happened was that accidents fell because people actually paid attention to actual risk, rather than relying on external stimuli to prompt action.
Background material here: –
https://en.wikipedia.org/wiki/Drachten
https://www.telegraph.co.uk/news/uknews/1533248/Is-this-the-end-of-the-road-for-traffic-lights.html
When you apply a stop loss to the market, you are effectively putting a barrier to how much loss you are willing to bear. That’s OK, but too tight and it will trigger too often, not delivering any improvement in strike rate. Too wide and you get no benefit. IMHO stop losses can be a bit like the town of Drachten, rely on them too strictly and you end up getting them to make your decisions and that randomise results. Remove them and you may make better decisions.
Everybody is looking for that elusive mechanical, systematic approach that can be flawlessly executed. But very often this doesn’t exist or at best is incredibly elusive. Good decisions are usually a culmination of factors that allow you make the correct decision. Just like the town of Drachten, relying on an arbitrary measure to base your judgement or attempt to ‘systemise’ your limits, may not actually improve your outcome, regardless of how sensible it seems.
Of course if you lack, or struggle to attain, discipline; then stops can be useful. But only when you use them as an arbitrary point do they really show their full colour. Too restrictive and you don’t gain. Sports markets are closed loops, so while you often see stuff shooting off into the distance never to return, very often it doesn’t and that’s the key to effective risk management in sports markets.
Category: Psychology, Trading strategies
