Capital Preservation And The Importance Of Stops

People very often enter the index futures market using a new a set up technique or jump on board following the momentum crowd based on a event that has spurred the market, with very little consideration given to their exit strategy. Seasoned veterans who understand the market and emini trading, know well planned exit strategies are the key to making money. It’s been said many times by many experienced traders and is worth mentioning once more: Cut your losses short and let your profits run!

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Although this sage advice has been preached for untold years, people fail to follow this cornerstone rule of trading the financial markets. The point of the rule, you will never be profitable as an emini futures trader until losses are cut short and bad trades exited quickly. Much effort is put into learning and recognizing trade set-ups and how to enter the market with very little placed on how to exit both profitable and losing trades. The trader will only taste success once he learns to master exiting trades and money management, or in this case, capital preservation.

Almost all experienced futures players have a trading strategy they use to enter and exit the markets with this strategy being their trading system. A trading system is not complete or does not exist until the trader knows what his exit strategy is before he enters the trade. Once the market presents a possible trade set up, a index futures trader should know what his exit will be before he ever enters the position, long or short. Knowing how you are going to take profits and letting them run should also be known before entering the position as well.

Setting Your Stop Loss

When a trader determines where he will place his stop loss, he is determining one very important factor: The trader is drawing a line and setting the maximum amount he is willing to lose on the trade should it go against him. However, determining where to place stops increases with experience and a clear understanding of market dynamics. Many market participants routinely place there stop loss in areas of recent support or resistance. The problem with this stop loss trading strategy is, everyone else knows where these support and resistance levels are located since they can read a chart also. The index futures market will very often reverse and execute protective stop orders in these areas then slowly return to the former market trend, leaving frustrated traders in it’s wake. This is where market experience and knowing market dynamics comes into play. Using a trading strategy that is not so obvious as placing your stop loss in the easily recognizable support and resistance areas is one tactic the trader may use.

Tight stops are one tactic that is beneficial to the inexperienced  market participants since they lend themselves to micro-controlling losses by losing less money . By utilizing tight stops, the trader can make more than one attempt to capture a big market if previous attempts failed. By losing less money on prior broken trades, the trader has enough powder to attempt subsequent trades to capture the move. However, tight stops require many more trades that involve small losses. For the trader that cannot tolerate many losses, tight stops should not be used. Transaction cost or brokerage trade execution fees should also be considered since this methodology will increase these cost. Finding a inexpensive broker is a must for traders that utilize tight stops.

Using stops based the amount of money they are willing to lose on each trade is another popular stop loss methodology utilized by trading participants. The trade simply determines the amount he is willing lose should the trade turn sour. The largest benefit of this type of stop is it is only known by the trader himself. Since the stop is more then likely not placed in an area of recent support and resistance, the odds of the market reversing to take out stop orders is almost nonexistent. Other traders use moving average stops when trading mini-sized contracts. Moving average crossovers happen when a shorter line moving average crosses over the larger moving average line, Many traders will execute their stops when these lines intersect.
Not only does the trader exit at these intersections, he also may execute another position going in the opposite direction since the index futures market will very often reverse when these moving averages intersect and cross one another.

Stops are not unlike road sign and signals we see while driving our automobile. These signs alert us of impending change or that danger may be lurking. Stops do the same. Just as when driving, we sometimes disregard the road signs and continue on our present path. We may not experience any danger but we are not driving safely. If we allow our protection stops to pass without initiating a exit trade, we are being unsafe.

Stops only work as an emini strategy if we react when these physical or mental areas are reached. How much faith you have in your trading system will be determined if you yield to it’s parameters and are not ruled by human emotion - fear and greed. Index futures trading is a profitable vocation and professional seasoned traders make an excellent living by plying their vocation. However, they did not reach this level of professionalism by following their emotions. The got where they are by implementing a system, testing it and following it’s rules based on market dynamics.

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