Equity Trailing Stop - When Do I Stop Trading for the Day?


Many times I hear traders say they just want to make a certain amount of money per day trading, perhaps they are happy with $200, $500 etc. For most of them, I find out they are coming into trading from a career where they received a regular paycheck for some pre-set amount. Unfortunately, trading does not offer any guaranteed income levels. Most traders with this pre-defined profit target find themselves behind in trading on a regular basis and are putting excess pressure on themselves.

 

For example, let's say you want to make $200 per day. The first day you trade and make $200. You are at par for the week. Now the next day, you lose $150 for the day. This means that when you come in to trade the next day, you will need to make $350 just to stay at par. If your strategy and or comfort level of trading is only designed to make $200 per day, you will find yourself having to take extra risk to make up this loss. This leads to making trading decisions based on money and not the market structure.


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At the same time, setting a pre-defined profit target will limit your full profit potential if the market wants to give you more money that day. How many times have you been trading and hit your profit target for the day, and then later in the day, if you had kept trading, you would have seen twice or three times as much profit? As the old market saying goes, "Let your profits run and cut your losses short," is still a good rule to follow.

Then there are traders who lose a very large amount of money early in the day and then they spend the rest of the day scratching and clawing their way back to break even. And history proves very few traders are able to do this consistently. This is why it is so very important to have a maximum dollar amount you are willing to lose per day and then immediately stop trading once you lose that amount. Your maximum dollar loss must be written in your trading plan. Do not just have a mental number in your head.

 

This is much like the mental stops people use in the market. Once the price starts trading near their mental stop, they come up with reasons to hold onto this trade, just hoping and praying it comes back, and most of us know that more times than not, it does not come back. Many traders find they begin making emotional trading decisions after they have lost a lot of money in the market. They stop following their trading plan and become very impulsive with trade selection. Once they lose even more, they turn into revenge traders who are just angry and trying to get their money back any way they can.

 

This usually means they start doubling up in the size of contracts traded, taking risky trade setups that normally they would have passed on, trading markets they are not familiar with just because they are desperate to find a trade, etc... At this point of the vicious cycle, the trader is only a short step away from financial ruin. Even if you do not find a need for this Equity Trailing Stop I am going to show you, please have a maximum loss amount per trading day written in your trading plan. If you don't have a plan, then write it on a Post-It note and place it on your monitor.

Now, I want to show you something I call an Equity Trailing Stop. The premise of this strategy is based on that saying we discussed earlier about letting our profits run and cutting our losses quickly. This tool will take into consideration what the market is willing to give or take on that particular trading day.

 

Figure 1

Figure 1 shows us a day where the market was sideways and did not offer much in the way of big profits. The Equity Trailing Stop probably would take you out of a market like this rather quickly because there is no apparent profit potential other than selling rallies and buying dips. This is fine until buying that dip turns into a bottomless pit, then all of those nice small profits are gone if you did not protect yourself with a stop.

Figure 2

Figure 2 shows us a day the market just ran in one direction, offering traders who stayed with the trend a very handsome profit. For those traders who took their $200 profit early in the morning and stopped trading, congratulations for following your plan. But look at the profit potential you gave up because you had a pre-defined profit target. Let's look at this Equity Trailing Stop and see if it can help you stay in the market until the market tells you to stop trading.

This strategy probably will impact traders who trade several times a day more than the trader who trades once or twice a day, but any trader can use this to their advantage.

Let's go through a trading day, entering some trades with both profits and losses, and see just when the markets tell us to stop trading. Remember, the most important part of trading is controlling losses. In the end, the only thing we can control is losses. There is no way we can tell the market how much we will make, but we certainly can tell the market how much we are willing to lose per trade. So have that maximum loss per day written down somewhere you can see it each trading day. I nicknamed this maximum loss for the day a "circuit breaker," much like the circuit breakers in our houses that are designed to turn off before a fire starts and burns down the entire house. This financial circuit breaker is designed to stop your losses for the day and allow you to come back tomorrow and trade. When we are having a bad day trading, we just need to know when to stop trading. Do not continue trading and searching for why you are having a bad day; this is not important at the moment. Just stop trading!! Later, after the emotions have calmed down, and trust me when you lose a lot of money, there will be emotions, then analyze what went wrong.
    

 

Table 1

Table 1 shows us a worksheet for figuring out when to stop trading for the day. In the upper right corner (yellow box), you will see I have listed a circuit breaker as $500. This means that on my very first trade, the most I can lose and continue trading is $500.

We also see that I made a trade and the profit of this trade was posted under Trade Results next to Trade #1. After this first trade, my cumulative profit or loss for the trading day is now $200. My Peak Equity is also $200. Peak Equity is the cumulative value of all your positive trades for the day. This is saying that at any one time during the trading day, you had actually earned this much money. Never treat this like house money and pretend it is not yours. This is a real profit you had made during the day at one point in time. The next column shows the Circuit Breaker. Notice how that number is now -$300. Why is this? Well, remember that the most we will lose before we stop trading for the trading day is $500. After our first trade, we now have made $200, so we subtract that $500 from this number and we now have -$300. Too many traders just leave their maximum loss for the day at -$500. This is wrong because now that you have made $200, if you let your Cumulative P/L (profit/loss) come back to -$500, you have actually lost -$700. This is why it is important to know exactly what your Peak Equity is during the trading day.
    

Table 2

Table 2 shows us Trade #2 was a profitable trade under Trade Results of $100. Notice how the Cumulative P/L went up to $300. The Peak Equity also went up to $300. Most importantly, our Circuit Breaker has moved up to -$200. As long as our next trade does not drop our Cumulative P/L for the day below our Circuit Breaker of -$200, then we can keep trading.
    

 

Table 3

Welcome to trading folks, we have a losing trade. Table 3 shows us that Trade #3 resulted in a loss of -$175. Going right we see that our Cumulative P/L for the day has dropped to $125. This column is nothing more than adding up your winners and subtracting the losers from them. Our Cumulative P/L for the day is still greater than -$200 so we can continue to trade. Look at our Peak Equity and notice it did not change from the previous trade. Why? Well, we did not have a profit on this last trade, so we just keep whatever the highest Peak Equity was before this trade and base our Circuit Breaker off of that number. Remember, the only way the Peak Equity can rise is if we have a profitable trade. For our next trade, as long as our Cumulative P/L for the day does not drop below -$200, we can continue to trade.
    

 

Table 4

Table 4 shows Trade #4 made $300 under Trade Results. This brings our Cumulative P/L for the day up to $425. Since we made a profit, this will also increase our Peak Equity column to $600. You are just adding your new profit to the original Peak Equity. Now, look at our Circuit Breaker column and we see $100. This means that as long as our next trade does not cause our Cumulative P/L for the day to drop under $100, we will continue to trade. This is how the Equity Trailing Stop works; we are taking our Circuit Breaker ($500) and subtracting it from each new Peak Equity value.
    

 

Table 5

Table 5 shows us that Trade #5 gave us a profit of $275 under the Trade Results column. This will increase our Cumulative P/L for the Day to $700. Notice how our Peak Equity increased by the amount of our profit to $875. We will now subtract our Circuit Breaker from our Peak Equity and we will see that we have $375 for a current Circuit Breaker. This means as long as the next trade does not drop our Cumulative P/L for the day below $375, we will continue to trade.
    


    

Table 6

Table 6 shows us that Trade #6 was a losing trade of -$330 under Trade Results. Notice how our Cumulative P/L for the day has dropped to $370. Immediately, we knew from the last trade that our Circuit Breaker would be tripped if our Cumulative P/L for the day were to close under $375, and we would stop trading immediately for the day.

This type of day happens a lot when the market has no real direction and spends most of its day in a range bound scenario. The key point here is that we kept trailing our Peak Equity with our Circuit Breaker ($500) to let us know when to stop trading for the day. Once the Cumulative P/L for the day dropped below the most recent Circuit Breaker, we stopped.

For this trading day, you would have made $375 if you stopped trading when the Circuit Breaker kicked in. If for some reason you just watched your Cumulative P/L for the day and said when that showed -$500, then you would have lost in reality -$1,375, because at one point during the trading day, you had made as much as $875 in profits.

This example was based on a $500 Circuit Breaker. Of course, each of us will have our own personal number to use. As you can see through the example, as you continued to make profits, the Equity Trailing Stop kept trailing along under your Cumulative P/L for the day. As the market started taking some of your profits back, it quickly moved your Circuit Breaker up to protect your hard-earned capital.

"When you talk, you repeat what you already know; when you listen, you often learn something." - Jared Sparks

Good Trading
- Don Dawson

About Don Dawson