Carmelo,
As you are seeing, different people address the issue in differing ways.
A stop is simply a risk management tool used to curtail or limit losses
on a trade that is going against you. Something like a vertical spread
is a defined risk strategy, which means that there is only so much that
can be lost on the position.
Whether you use a stop on a spread really comes down to one question.
Are you willing to take a maximum loss on the spread?
As a trader, our goal is to create what is often termed a "positive
expectancy." This simply means that given a pattern of consistent
trading, that over time your profits will out pace your losses. So, for
example, if your trade has a 50/50 chance of succeeding, then you will
need to make more on each winning trade than the loss you incur on the
losing trades. In contrast, if you have 9 winners to every 1 loser, you
can afford to take smaller profits on the winning trades so long as the
combined total outpaces the losses on the one unprofitable position.
I have, and do, use stop orders on some spread positions but it is not
frequent. My preference is to open additional spread trades and/or
adjust the existing position. The goal is the same as it is with a stop
loss order; to limit losses.
Getting back to the question of taking a maximum loss on a spread trade,
if you cannot comfortably answer that question with a "yes," you really
need to question whether you're trading too much size. In other words,
rather than employing a stop loss order to pull you out of the spread
should the losses mount to an undesirable point question whether you
would be better off trading fewer contracts or a smaller product.
The bottom line is that its all a risk management issue. We need to
limit losses so that our profits can keep us in the game. If your
current risk/reward picture does not allow for that, then maybe a stop
loss order may be of benefit. At a minimum, you need to evaluate your
trade plan and determine how to shift the probabilities to your favor.
Christopher Smith
TheOptionClub.
--- In OptionClub@yahoogro
>
> I believe this came up briefly in the past, but I was hoping we could
reiterate this.
>
> Question: "Do you use stops on your spread trades?"
>
> I have been using stops; and I've been stopped out on a couple of
positions where it would have been better to have no stop in place as
the price reverted back promptly. I took a loss and didn't have to.
>
> Thanks for the input!
>
> Carmelo
>
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