In the market, we often encounter two similar situations as follows.
① Consecutive stop losses
② The market just hit a stop loss and then returned to its original direction.
We all know that stop losses are fundamental in trading. This is the most basic skill, and I believe it is also the hardest skill in trading. Why is it the most basic? Because as long as you are an investor in the market, no matter your trading style or level, you know the importance of stop losses. You may not truly understand this, just having heard others mention it, but in short, you know it is an unavoidable issue on your trading journey!
Why is this considered the hardest? Because you find that after trading for many years, you still do not understand how to set stop losses. In fact, if we discuss the stop loss issue purely from a technical perspective, it is not difficult. The difficulty comes from the fact that most of our fears stem from the unknown and the fear of potential future losses. Moreover, one cold hard reality is that this fear does not diminish with increased trading experience.
In this sense, many people internally do not accept losses. Therefore, the purpose of learning techniques has never been to engage in scientifically reasonable trading, but to evade losses. This raises the difficulty of the task by many levels.
This leads to the two situations mentioned above. From a trading perspective, these two situations are not worth discussing, but everyone wants to seek technical solutions because these events can naturally occur in trading. Moreover, in the trading data of many professional traders, there are countless instances of consecutive losses followed by stop losses that return to the original direction, but this does not affect their eventual profitability.
Many problems in trading are not really problems; unfortunately, people do not accept this, so it becomes a problem. I believe that the core of solving problems lies in accepting all situations that arise. These two situations are not the key to determining success or failure; the ultimate success or failure actually depends on whether you can consistently increase your risk-reward ratio over the long term, rather than whether you can use technical means to prevent uncertain future events from occurring. This not only puts pressure on yourself but also pits your will against the market. Such individuals are unlikely to make correct trading decisions.
This is the conceptual level, so what is the ultimate achievement we can achieve from a technical perspective? Rather than talking about what technology to use to solve it, I would prefer to discuss how I think about the role of technology in this process and its significance.
First, we should understand that in trading, stop losses are a common occurrence. However, how to stop losses is something we can choose ourselves. We can decide how much to lose and how to lose.
Why do consecutive losses occur???
It is generally a problem with the self-set strategy. You must understand that the smaller your stop loss, the higher the probability of hitting it. This is also why we see some very strange strategies in the market that use large stop losses or even no stop losses to achieve very small take profits. The characteristic of this approach is a high win rate but small take profits. Although the take profit is small, the number of trades can make it appear dazzling. On good occasions, it is possible to maintain a very high win rate or even high returns for several months.
Many people even use this method to add positions against the trend, calling it a grid strategy, loss-adding strategy, or Martingale strategy. The method is quite wild, but the final outcome can be tragic: numerous small take profits followed by a significant loss or even a margin call.
Now that we have discussed this strategy, the opposite is a strategy of small stop losses with no arbitrary take profit. This is the ultimate path for all traders. I mean all traders. Don't mention high-frequency quantitative trading, short-term trading, etc. Even in short-term trading, a good risk-reward ratio is essential. Using small stop losses to seek larger profits is a mindset that will never change.
So here I want to say one thing: mature traders, especially those using trend-following or trial-and-error strategies, will almost always encounter consecutive stop losses. This is common and does not indicate that there is something wrong with the strategy.
Thus, we conclude that the smaller the stop loss, the higher the probability of hitting it. Short-term stop losses are small, so they often get hit, while swing stop losses are relatively larger, resulting in lower frequency of stop losses. However, the requirements for profitable positions will also be higher.
Why can't many people profit? It's not because they incur many losses, but rather because they cannot balance the relationship between stop losses and profits. This requires a long-term effect; it is not just about one or two losses being wrong, but whether your average profit per trade can multiply your average loss per trade over the long run. There is also a professional term called expected return, which refers to the potential profit value of every trade, derived from long-term data.
Therefore, consecutive stop losses are likely because your stop losses are too small. This isn't really the issue; the problem lies in whether your strategy can still be fully executed after this. Originally a good strategy may end up being unmanageable, and then the next trade could be a big opportunity for profit. Many people have encountered this situation: after consecutive losses, they hesitate to trade, and then when the market moves, they feel regret.
To avoid consecutive losses, several issues must be designed right from the outset of the system. The first is frequency. If the signal frequency of a certain variety is too high, then consecutive losses will inevitably occur because the frequency becomes uncontrollable. Profit and loss are essentially a matter of probability, and consecutive losses may just happen during that period, which is unavoidable.
So how about the frequency? This is actually linked to your trading style. For short-term trading, you might execute 1-2 trades a day, while for swing trading, you could be looking at 1-2 trades a week or even less, with relatively larger stop losses and lower probabilities of hitting those stop losses.
Here we can draw a conclusion: trading should ideally be based on low frequency with a relatively larger stop loss for entry. A larger stop loss means a lower chance of being hurt by random market movements, increasing your probability of participating in genuine market trends. If the stop loss is smaller, you must confine the market's movements to an extremely narrow range, which is incredibly difficult and can lead to worsening mental state over time.
Widen the stop loss. As for how much to widen it, that's a matter of level selection. You must understand that the larger the level, the higher the stability of the trend. A larger stop loss likely indicates a reversal, while smaller level trends have a lot of randomness, but larger level trends have a strong inevitability.
For example, when you choose to participate in a daily level market trend, you shouldn't look for signals on the 1-minute or 5-minute charts. The more signals there are, the more mistakes you will make. Through observation, we can see that the formation of a high or low point at the daily level often takes 2-3 days. Generally, within 2-3 days, there is likely to be only one trading opportunity. According to an effective trial-and-error mechanism, if you lose this time, the market will likely enter a larger cycle of oscillation. This means the daily chart will have one or two pullbacks, and during the next trade, the construction of the low point will also be completed in 2-3 days, leading to only one opportunity.
Therefore, regarding the design of trading, as long as it is an effective signal, there is basically only one opportunity at a swing low point. Why does it appear multiple times? This is because the market has not yet developed the trend and has returned to the consolidation range to form the signal again. You can think of it as oscillation, but I believe it is not accurate to describe it as such.
For example, we can see that before any daily level market trend emerges, the market often shows two high points and two low points, so it seems that there are multiple trading opportunities. We can observe this situation from smaller levels.
This leads to the situation where there are multiple entries in the same region before the trend emerges, but the frequency is not high because the stop losses are relatively large and more reasonable, being at a swing low point. This is a normal trading pattern for a swing.
In summary, we need to abandon small stop losses and small take profits, and instead use larger stop losses and larger take profits. Many people are unwilling to do this because they cannot find a reasonable trading model or a viable profit path. They can't articulate how to achieve profitability through market movements. They think it's about the number of trades, but in reality, we achieve profits by leveraging larger market movements to improve the risk-reward ratio.
They are afraid to use large stop losses because they cannot see larger trends and are only lingering in small trends. They also lack the courage and confidence to participate in larger trends. They do not believe in their holding capacity, so they can only lower profit expectations, leading to lower stop losses. Once the stop loss is lowered, the fatal problem arises: consecutive stop losses.
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