Adrian Reid (Enlightened Stock Trading) argues that placing stop-loss orders directly in the market often causes exits at points of maximum fear (low intraday wicks), reducing profitability. He recommends using chart-based "next bar on open" stops for exits (letting intraday fear subside) and in-market profit targets (to capture intraday greed), but—crucially—urges traders to backtest both approaches. He reports a concrete backtest result: a Hong Kong momentum system showed ~30% better expectancy using next-bar open stops versus in-market stops. He recommends Amibroker for large-scale backtesting across many stocks and periods.
Questions this video answers
September 24, 2021
~30% better expectancy (Hong Kong momentum system)
Amibroker
A Hong Kong momentum-based trading system
Did you know that placing a stop loss order with your broker in the market when they're trading could be ruining your trading profitability?
My name is Adrian Reid. This is enlightened stock trading. And enlightened stock trading is all about having confidence in your trading by proving that you're making the right decisions analytically through backtesting your systems. Now check this out. This is what happens. This is what we're conditioned to believe will happen if we don't have a stop loss in the market. So.
Let'S say we entered the trade on this candle here and we placed our stop loss. The trade's going along fine and our stop loss is in the market and the candle touches the stop loss and we want to get out because what we're afraid of is the next bar. This is going to happen, there's going to be a massive gap down and if we don't get our trade, our stop loss executed in the market, then this is what we're going to suffer. We're going to have this massive loss here. Now that can happen, absolutely no question. But here's what happens more often than not. If you've got a stop loss order placed in the market, you enter the trade on the candle, you place your stop loss and then the trade's going along fine. And then someone dumps a big sell order into the market which causes a massive wick down and then at the end of the day, the market closes way up here. Now in this situation, if you have a stop loss in the market, this is where your order is going to get executed. If you're lucky, if you're unlucky, it's going to get executed down here somewhere because of slippage. And chances are you could get executed right at the low of the day with an in market stop. But if you, instead of having an in market stop loss, if you have a next bar on open stop or a chart based stop, so you have this line on your chart or this sell point in mind. And if the stock touches this point during the day, then the next bar at the open here you get out. What happens is that gives the market time for the fear to subside. Because market is all about trading effectively in the markets, is all about managing fear and greed, right? And the lower wick of your candle is the fear and the upper wick is the greed. And a lot of the times during the day it's the intraday fear when something bad happens or when there's a news announcement or when someone dumps a big sell Order into the market, the candle drops way down and touches people's stop loss and gets you out. And that fear is temporary. It subsides because the market is mean reverting fear and greed and emotion in the stock market and in the crypto markets, especially in the crypto markets, is mean reverting extreme fear gives way to normality and greed and greed gives way to normality and fear. And so volatility up and down is constant. And if you're placing your stop loss orders in the market, then you are always getting executed at the point of maximum fear and that's taking you out at the low point of the trade. Now you need a stop loss, no question, don't get me wrong about that. But if you place your stop loss order in the market, like we said over here, placing a stop loss order in the market will always get you out, sorry, here. Will always get you out at the point of maximum fear. And we don't necessarily want to get out there. We want to get out at the point of maximum protection or profit. And by letting that fear subside. So if you're trading on daily bars, this is a daily bar, letting that fear subside and getting out the next bar in the open gives the market a chance to normalize a little bit. Now it's true that sometimes if you don't have your order in the market, instead of the market bouncing and you getting out here, it could gap down and you could get executed here instead at the next bar at the open and have a bigger loss than what ideally you would like. But this is a numbers game. One of the things a lot of people miss about trading is it's all about the numbers and the next thousand trades or the next hundred trades. And so what you got to do instead of looking at this one trade and say, hey, I didn't execute my stop loss and then I got out the next bar and open way down here. That's one trade. See? Proof that it's a bad idea. That's not true. That's one data point. Instead, what you need to do is back test your system with an in market stop loss and back test your system with the next bar and open stop loss and numerically analytically compare the difference in profitability. Now I've done this for all of my systems and I got a trading system in Hong Kong, it's momentum based system. And with that system, a next bar and open stop loss gives a 30% better expectancy than a in market stop loss, 30% uplift in expectancy just by having a next bar and openstock instead of in market. And I've got a number of crypto trading systems, cryptocurrency trading systems, and they all work dramatically better with next bar and openstocks. If you have crypto markets are so volatile, these down wicks can be really big, really vicious. But if you just give them a chance to calm down a little bit, the market often bounces back and you get out at a much better price. So next bar and open stops makes a huge difference. Now if you also take this logic and flip it on its head, think about a profit target. Now, not all systems should have a profit target, but some profit targets work well. And if you have a profit target, you want to maximize your chance of getting out at the proper target. So the way you do that is you have an in market profit target, okay? Because at the point of maximum fear, maximum euphoria during the day, you want your profit target to get executed. You don't want to wait for the next bar on open because then that greed will probably subside. It'll revert back to normal. You'll get out actually at a lower price. So again, what you want to do is prove this through backtesting and you want to backtest with a package like amibroker, it's very easy to do. It's just like a simple little toggle that you switch, flip, flick in the profit target or in the stop loss to go from next bar and open to in market and back again. And what you'll see when you have a profit target is that an in market profit target is much more profitable generally than a next bar and open profit target because you're capitalizing on the greed that's going on in the market. Just like with a stop loss, you want the reverse going on. You don't want to be impacted by the fear. You want to let the fear subside and then get out at a more normal price. But when you got a profit target, you want to capitalize on the greed. So you have an in market profit target. But again, test this for yourself. If you're not trading systematically, then these are the sorts of reasons, these are the sorts of things that you can do when you make that step to trade systematically. You can test and prove all of these things in data very, very quickly, very, very easily, and not just by looking at one or two charts. When you're back testing this sort of concept in amibroker, it's very easy to test over a few thousand stocks in the market. Over 20 to 30 years of stock market history in almost the blink of an eye. A couple of seconds and you'll get the data to prove or disprove that hypothesis. So that's how you become an enlightened stock trader. That's how you improve your profitability by testing these concepts that people have been scouting for years. But they're just crap, right? So think about it. Are using in market stop losses? It's time to think about should I maybe use a next bar on open stop loss? Are you using a profit target? So that should probably be an in market profit target. And either way, if you haven't back tested your trading system, that's your next step. So if you need help with that, comment below back testing and I'll give you some resources to help you point you in the right direction to improve your trading systematically by backtesting. That's all for this video. My name is Adrian Reid. This is enlightened stock trading. Comment back testing below if you want to learn how to do this. Bye for now.
