Emini Trading Blog

E-Mini says “stop”? Active traders tend to be a dynamic group of individuals. They tend to hear the word “stop” as a negative. Stop (or slowdown) is not normally a part of their vocabulary. Nevertheless active traders would do well to become familiar with this mechanism. In our business stops are one of the most important tools we have. Stop-loss orders help us avoid the number one obstacle to consistent trading success: emotional trading. By planning our stops in advance we effectively eliminate the all-too-human instinct to “wing-it”. An overview of stop orders is a good first step in understanding and using them consistently in our day-to-day trading.

Stops are a form of insurance. Remember, all traders suffer losses – it’s the nature of the business. Our goal is to limit our financial exposure to acceptable levels and more importantly, to avoid emotional turmoil when we do experience losses. Trading emotionally is like letting an intoxicated friend drive your vehicle. As a refresher – some definitions and things to keep in mind.

A stop order is an order placed with a brokerage that specifies that when a predetermined price is reached, a market order to sell that security is issued. Thus, if you determine that you want to limit your loss exposure to 10% you would enter a stop-loss order at 10% below your entry price, effectively limiting the amount you may lose to 10% should the market turn against you. Depending on what type of order it is, you can specify sell price, buy price or both. Stop loss orders are also called protective stops for obvious reasons. It’s a little like putting a collar and chain on your dog so when he takes off after a passing bus he gets so far and the length of chain runs out and he suddenly…stops!

Stop-loss orders are great forms of insurance – there is no cost to place a stop and it sits there waiting patiently until the target price is hit. The stop loss then becomes a market order and the desired transaction takes place. Some things to keep in mind regarding stop loss orders:

1 – Just because a target price is reached and your stop-loss becomes a market order, doesn’t mean you will get that price. In fast moving, volatile markets as the e-minis often are, a security may fall quickly below your target price. This is a potent argument for actively monitoring your trades.

2 – One of the essential times to use stop-loss orders is when you go on vacation or business trips and your ability to monitor your trades is limited. Swing traders and long-term investors would do well to become familiar with this mechanism in these instances.

3 – A “Good-’til-Cancelled” (GTC) order is an order that allows you to cancel the order at a future date (although most brokerages limit a GTC order to a maximum of 90 days.).

4 – A “Day” order is an order without an expiration date. If, at the end of the trading day, the target price is not reached, the day order expires. You will have to re-enter the order the next trading day.

5 – Be aware that market orders and limit orders serve different objectives. When you enter a market order you want to enter the market right away at the prevailing bid/ask price. A limit order specifies a price that you want to buy or sell at. Limit orders typically have higher transaction costs than market orders.

6 – Don’t use mental stops when you trade - they invariably move!

7 – When determining where your stops will be, consider your total equity capital. Any single stop calculation must take into account how much this potential loss will affect your total investment capital. Many experienced traders recommend that you set a percentage of total trading capital that you can afford to lose in a month (2 – 3% is a common figure). Avoid setting stop-loss orders at a percentage that would result in your total trading capital going below your goal.

8 – Be careful not to place your stop so that normal market movements trigger the stop prematurely. A good tool for determining placement of the stop is the security’s beta factor. A beta of one or two suggests less volatility and a tight, relatively close (to purchase price) stop is appropriate. A beta of up to three indicates increased volatility and the need for a “looser” stop.

9 – Leave your stop alone unless you have a paper profit. At that point you are ready to use “trailing stops” to protect and “lock-in” your profits. Note that many brokerages do not support trailing stops so check with your brokerage to be sure.

I’m sure every reader can remember the grade school game, “Simon Says”. Let’s update that to “E-Mini Says”. When E-Mini says “stop” that is our signal to trade the E-mini’s rationally in a disciplined, professional manner. The profits will flow to the extent that we consistently use the tools available – including stops. Now, E-Mini says “Go”…