by Alexander Mirolubov
My teacher said: "Never set stop-losses when you place your order with some broker'.
It happened when I was studying the art of trading. At that time, it was very confusing: stop-losses were a common practice, and those who had already begun their trading were teasing the novices who did know this "wisdom" yet. I was also anticipating the moment when I would do this thing as "a real trader", and then that statement of my Teacher...
Let me explain you something.
"Stop-loss" is a part of a brokerage's order form. There you define the conditions under which the broker must sell your shares. These conditions describe a situation when the market value of your tradable goes over some critical limit that you have set up for your acceptable loss.
At a first glance, it is a very nice feature: it looks like a warranty against a probable loss if you are wrong with your forecast or your trading strategy.
But... There is always a "but".
Consider this (as my teacher said): the stop-loss is a sign for the broker to clean up some position exactly at the start of the market movement long expected by the trader. The broker may tell later that there was a moment when the price went over the critical value defined by the trader; and there is no way to confirm or refute that statement.
In case of market panic, when everybody sells and the market price falls down like a stone, the stop-loss intended to protect you will actually add more to your disaster. Why? It is simple: your broker may tell you that it was not possible to sell your actives at the stop-loss price due to the panic. It means that you have to sell at the very bottom, and your loss will be tremendous.
The reason is that a broker's duty is not helping you to make money, the broker makes money for him/herself first. So, my teacher, Sergey Golubitsky, says that it would be better to set up the stop-losses in your head only. Thus, facing some extraordinary situation, you will rely on yourself only, not expecting some help from a total stranger.
And it would be even better if you hedge your position buying some options. This is the way how I do it; I do not use stop-losses at all, it is my credo.
I do believe that the majority of the brokers we work with are honest people. However, we allow ourselves to become an object of some manipulation, easily and without a second thought!
This is what I would like to discuss with you.
I have a friend, a very successful trader (he trades gold mostly). He says: "Trading is not for those with a weak will; trading is very similar to the ancient art of a warrior or a hunter. A person who chooses that path will have to face all his weaknesses and all impurities of his soul".
Therefore, when we define stop-losses, we have already capitulated; we have agreed that we cannot "hold against the enemy's strike"; we have delegated our ability to act and fight - to some other person, to a broker. Just in case. Believing that this is a smart move... We have lost a battle not actually starting it.
Consider one more thing. The information of all stop-losses (coming from all traders dealing with that brokerage) is accumulated by your brokers. Very often those brokers either work for or are affiliated with big banks and big international companies - your biggest and worst competition. It means, that you yourselves, voluntary, provide your competitors with a confidential information. They take these stop-loss info into account and use it from time to time against the traders' community. And the traders' community goes later into the long discussions regarding how they - big banks - do that, how do they know, etc. How do they know? Just because you have told them yourselves about your fears, your expectations, about the levels of your acceptable risk... Do they need to know more to make you sell your actives when they want it?..
However, this consideration is not the most important one. You need to remember that any time you set up a stop-loss - even in your head only! - you switch from trading as a job (though risky and dangerous, it is a job!) to trading as gambling in some casino. In this regard, I prefer a paradigm formulated by Warren Buffett.
What can I recommend to a novice trader? In brief, I would divide all tradable assets on two groups. One group consists of tradables that, in case of their downward movement, make you feel and think, with every point down, as you are pushed closer to the edge of the disaster. (The "good" examples of that type are 30 times downfall of the price of the metal rhodium in 2006 or the end of dotcome's era.)
Another group is an opposition of the first one: with every down point of its price movement, the tradable of this group gives you a feeling that the moment of buying is coming as well as the start of the bull's revenge.
I believe that it is preferable to trade the second group, the tradables that you can trust not because they are now in fashion but because they have some strategic perspective. It means that you will have always a chance to get away, and with some reasonable profit. Accordingly, in this case there is no necessity to set up a stop loss, and you as a trader will follow an example of big players (institutions) who prefer to play safe and have everything (or almost everything) under control.
In regards to all the above, the only market of the second type that I know is the gold market (and shares of the gold-mining companies). Other markets are confusing, especially at these uncertain times.
So, as you have guessed probably, I do not trade anything except gold. At least, now... And it allows me to follow my ideals and keeps me out of the necessity to put stop-losses.
And one more thing: you should have enough liquidity always. It will help you to be prepared to any development of the market situation instead of holding to just one forecasted scenario.
December 10, 2011