Can a trade turn into a loss when it is stopped out at initial entry price?
Yes it can and is a stop-loss management mistake. The concepts involved are position sizing, stop-loss management and centre of gravity which I wrote about adding to a winning trade here and expanded here.
I received two student-submitted statements showing real trades on a live account for WTI today. I present one of them (Student A) here for discussion and learning.
Real WTI trade on 12 June and stopped out at loss on 17 June
Here are some facts (match with labels on chart below):
- First entry of 0.07 contracts entered at $105.39 on 12 June (blue 1).
- Half an hour later, 0.15 contracts added at $105.57 (blue 2).
- At WTI high of #107.65 some 14 hours later, the combined position of 0.22 contracts was in profit of $470.20 (black 1).
- Smelling that geopolitical risk from Iraq and Ukraine and positive technical picture, Student A made entry #3 with 0.10 contract size at $106.96 on 13 June (blue 3).
- At this level (blue 3/black 2), the overall position of now 0.32 contract size still enjoyed a diminished profit of $318.40.
- Hunting for further entry points, Student A entered entries #4 and #5 with contract sizes of 0.1 at 106.78 (blue 4) and 0.1 at 106.46 (blue 5) respectively.
- All of this time, all entries were managed with stop-loss set at 105.57-59 (red X), a zone that reflected break-even based on the higher of entry #2 (blue 2).
- The whole basket of 0.52 contracts lost $414.82.
Looking at this trade using the concept of Centre of Gravity
Centre of gravity is a very good analogy to describe the average entry price of a series of trades. CG describes the concept of tipping point which is immediately clear to all of us. CG applied to position sizing describes the weighted average entry price of a combined position when it was entered at different price levels in different sizes.
Applied to this WTI, trade, we can see why the whole basket ended up losing money. CG can be calculated which in the following manner.
Weighted average price (CG)
- CG #1 – Weighted average entry price of entries #1 and #2 is 105.512
- CG #2 – Weighted average entry price of entries #1 – 3 is 105.965
- CG #3 – Weighted average entry price of entries #1 – 5 is 106.217
Mistake: Stop-loss level was placed below weighted average price
If stop-loss is a safety net, then as the CG rose (gasp! CG moves?!), the original stop-loss level was no longer adequate for the protection of the combined position. Instead of a break-even or slightly in-the-profit, the stop-loss that was placed was deep inside a ‘loss’ zone.
Simple guide to manage stop-loss levels
What should a trader do to protect this combined WTI trade? There are different models applying position sizing factors. These are active ways to manage the weight average price of entry.
The simpler approach is to apply stop-loss orders that follow the movement of CG i.e. weighted average prices of $105.12 after entries #1 and #2, $105.965 after entry #3 and then $106.217 after entry #5.
According to individual risk aversion, stop-loss orders can be placed at:
A) Exactly at CG for break-even
B) Slightly below CG for small loss but lower probability of trigger
C) Above CG for small gain if triggered but higher probability for trade to be closed.
Traders should also consider the placement of stop-loss levels in relation to support levels.
Director, TerraSeeds Market Technician Pte Ltd. Trader, investor. @sohtionghum was picked ‘Top 70 Forex Twitter in 2015’. Operates multiple strategies.
“Dear reader, I do not have a financial license to give advice. I do not know you the reader. Your financial objective and risk tolerance may be different from mine. I am not responsible for any consequence of your action.