Risk Management, Stop Strategy, Eliminating Impulsive Trades

One broad theme from my 2024 Trading Principles is risk management. Specifically refining my strategy for using stops, and eliminating impulsive trades.

Stop Strategy

I’m basing my stop strategy on Market Wizard Bruce Kovner’s approach:

Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. For example, if the market is in the midst of a trading range, it makes no sense to put your stop within that range, since you are likely to be taken out. I always place my stop beyond some technical barrier.

Bruce Kovner in Market Wizards

In the book author Jack D. Schwager expands upon Kovner’s approach in executing stops:

Kovner maximizes the chances that he will not be stopped out of a trade that proves correct, while at the same time maintaining rigid money management discipline. The philosophy behind this approach is that it is better to allocate the predetermined maximum dollar risk in a trade to a smaller number of contracts, while using a wider stop. This is the exact reverse of the typical trader, who will try to limit the loss per contract, but trade as many contracts as possible—an approach which usually results in many good trades being stopped out before the market moves in the anticipated direction.

Market Wizards

Eliminating Impulsive Trades

The other piece of my risk management theme is to eliminate impulsive trades.

It’s very tempting to jump into a trade at the first sign of increased tempo. Especially if you’ve been sitting dormant for 30+ minutes. You fear “missing the move”.

My objective is to let these initial bursts of tempo play out without impulsively jumping in to catch them. Like a foundational strategy of mindfulness, you observe the surge of thoughts, but you do not act on them. You sit with them and let them pass by.

Let the thousands of other traders watching the same exact charts be the first to react. Half will be right, half will be wrong, and a market will be made.

A tactical strategy for eliminating impulsive trades is to log every trade prior to executing it. My method is to write out the trade in a notebook first, execute the trade, and then log it in a spreadsheet. The initial step of manually writing down the trade helps with subduing the urge to execute an impulsive trade.

I write out the trade using the acronym PST: Price, Stop, Target. Price is the average price I’d like to get in at, Stop is the price I’m 100% out if the trade goes against me, and Target is my initial level for taking profits.