Using pit-trader’s ‘backstops’ to defend your positions

Do you even NEED a stop loss? 

(How pit traders did it all without a safety net)

What part of your trading strategy do you think has the single biggest effect on your results?

Personally, if I could only focus on one thing, I’d look way beyond entry signals or any of the stuff that gets you into trades. I’d actually drill-down on what gets you OUT of trades.

After all, the money is made or lost at the point a trade is exited.

And an integral part of the exit strategy is our old friend: the stop loss.

Now stop loss placement and management are two very personal issues. There’s simply no single right or wrong way to do it; no one-size-fits-all. There are as many different stop loss approaches as there are traders because we each have our own goals for our trades and different tolerances to risk.

But let’s play devil’s advocate for a minute… what if you didn’t use a stop loss order at all?

What if you went into the market without the customary safety net of a stop loss order in place?

It certainly goes against all common trading advice but could there actually be a way to throw the rule-book out of the window and make this work?

Completely contrary to all common wisdom, I’ve known very successful futures scalpers trade without stop losses…

It’s not what I’d recommend WE do. At least not until you’re a total master of the craft.

But I thought I’d share this with you. You won’t see this mentioned in any of the trading books, but sometimes you can learn more by spinning conventional wisdom on its head and seeing how things look from the polar opposite position.

Especially when you know the ‘experts in the field’ are doing it too!

So basically, what these guys do is find a very strong support / resistance level and use that as a ‘backstop’.

How to use support or resistance as your ‘backstop’

For example, the market is trading at 1.3724 and a strong resistance level has been spotted almost 50 pips higher at 1.3772…

Now they might sell into any up-move at 10 pip incremental steps (i.e. they’ll have limit sell orders working at 1.3734, 1.3744, 1.3754, 1.3764) and then they’ll just work the position…

They get filled at 34 and the market carries on moving up, filling them again at 44 (the position is now a 2-lot averaged at 39).

The market dips a bit and they take one-lot off at 38 (the position is now a 1-lot averaged at 40).

The market rises filling them at 54 and again at 64 (position is now a 3-lot averaged at 53).

The market dips and they unload the entire 3-lot at 40 (giving them 39pips profit on their 3-lot position (13pips per lot), and so-on.

With this approach they’re constantly scaling in and out, riding the ebb and flow of the market’s tide. They’ll work the position, grabbing a few pips here, letting it run against them, scaling-in with more entry orders and then grabbing a few more pips when the markets flows back in their favour.

The resistance level (hopefully!) puts a cap on the markets up-move. It lets them scalp away in its shadow with an element of protection.

But of course the inevitable does happen from time to time…

If the market blasts through the level they’re using as a backstop, they bail out immediately and take the loss. It’s quaintly known as ‘spewing’ your position.

So yes, from time to time they’ll have to swallow a loss. But this is all about playing the probabilities. And the times they’re banking substantial profits can more than cover the occasional trades that go bad.

This is how many of the futures pit ‘locals’ traded before the great migration to computerised trading. Because they were absorbing the buying or selling coming into the pit from the various brokerages and institutional clients, they were often positioned against the short-term trend.

In fact, they couldn’t have placed a stop loss order even if they wanted to. They were trading in the physical environment of hand gestures and head nods, so when they wanted to cover their positions they had to make the right signs and find a counterparty to take the other side of the trade, hopefully before the market had already moved too far!

Riding positions like I described above was how they created a viable edge for themselves, even though they would often appear to be trading against the immediate price action.

And there was only one prerequisite: nerves of steel!

The traders that were best at trading like this were the ones who could disconnect money from trading results.

Sure, they had to keep score so they always knew where their positions stood at any given time, but it really was a case of them keeping track of the ‘score’ – seeing things like a game, with points won or lost – rather than sweating over the effect of their activities in terms of cash.

When I was doing my training for scalping the Bond Futures, they had us practicing on the Mini-Dow futures like this. You had to have a position (at least a one-lot) and you had to work that position like I described. You actually were not allowed to be flat, even if the market wasn’t really moving anywhere!

The idea was (and I think it’s 100% correct by the way) that when you are invested in, committed to and closely monitoring a position in the market, you start noticing little quirks that you probably wouldn’t see otherwise. You make faster progress than you ever could by being just a passive observer.

Now it is a pretty advanced way of trading. It’s completely foreign to how most people are looking at the markets these days, and it’s certainly not for everyone. But I do feel it’s important for me to pass this stuff on to you.

You never know: one of these ideas might just be the catalyst for your own great trading breakthrough!

Be Prepared: Market Moving Data Coming This Week (London Time)

Wednesday 2nd March
09:30    GBP    Construction PMI
13:15    USD    ADP Non-farm employment change
15:30    USD    Crude Oil inventories

Thursday 3rd March
09:30    GBP    Services PMI
15:00    USD    ISM Non-manufacturing PMI

Friday 4th March
00:30    AUD    Retail Sales
13:30    USD     Non-farm payroll & unemployment rates

Monday 7th March
23:50    JPY    Gross Domestic Product

Tuesday 8th March
02:57    CNY    China trade Balance

So we have quite a sparse economic calendar ahead of us this week in terms of events, but there are a couple of biggies to watch…

Keep an eye on the US employment data on Friday: that’ll be closely watched after last month’s unexpectedly low number.

And things will likely be a bit twitchy in GBP markets in coming weeks, as players anticipate the effect of the coming ‘Brexit’ referendum. British gross domestic product figures for the 4th quarter of 2015 fell broadly in-line with expectations last Thursday, but Construction PMI on Wednesday morning and the Services PMI on Thursday could shake things up a bit this week.

Trade safely, and I’ll catch you next time…

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