12.14.2008

Hard and soft stops.

A hard stop is an order you place in the market. A soft stop is the number you keep in your mind, prepared to act as soon as the market reaches that level. The distinction between them is extremely important, but I am a little reluctant to discuss soft stops here. It is a topic for professional and semi-professional traders, and I am concerned that some beginners may misunderstand and misuse it. For most beginners, a soft stop is like no stop at all.

This reminds me of a TV commercial I once saw—a company advertised a soft drink by showing people on small motorbikes zooming up and down steep slopes. Splattered across the bottom of the screen in big white letters was a warning: “All tricks performed by trained professionals. Kids: do not attempt to duplicate at home!” And that’s exactly what I’d like to say about soft stops.

If the topic is so dangerous, why not leave it out of the book altogether?

Because I want this book to be useful for the people who are rising to a higher level of trading who may find hard stops too rigid. I want to put control into your hands, trusting you to make reasonable decisions.


Just remember that hard stops are for everybody, but soft stops are permitted only for the pros or serious semi-pros.

Whatever method you use for setting stops, in the end you will come up with a number—the level at which your stop belongs for the next trading day. Will you make that number a hard or a soft stop?

A hard stop goes into the market as a specific order—you actually give it to your broker. The big plus of a hard stop is that it allows you to take your eyes off the market. It is perfect for those who cannot be in front of the screen during trading hours and who do not like making decisions in real-time. Beginners must use hard stops because they have neither the expertise nor the discipline to make decisions in real-time and carry them out.

Professional systematic traders use hard stops, but professional discretionary traders may use either hard or soft stops. A pro can do his research, come up with a number for a stop and enter it into his record-keeping system—but he may not necessarily give that order to his broker. He may watch that level, prepared to exit if prices get near it, but give himself a bit of latitude at the same time.

Using soft stops requires two things—iron discipline and full-time attention to the screen. You have no business using soft stops if you are not in front of the screen, ready to execute a trade when the market hits your level. You also need absolute discipline. A beginner who freezes in fear and keeps hoping for a lucky break when the market turns against him should not be using soft stops.

Soft stops can provide a terrific benefit by allowing more flexibility than hard stops. As the market starts heading down towards your stop level, you may decide that the stock looks heavy and get out earlier; you may cut losses sooner and save more money. Alternatively, you may decide that a decline on low volume could be a fakeout move and hold the stock a little longer, giving it a chance to recover. Needless to say, in all of these situations you need to know exactly where your stop is and exactly how you are deviating from it. An experienced professional can benefit from the flexibility of a soft stop, but too much freedom is deadly for beginners.

A trader has no right to use soft stops until he or she has traded profitably for one full year. Even then you may adopt soft stops only slowly and continue to use hard stops when you are away from the screen.

Since the decision-making process for establishing stop levels is the same for hard and soft stops, I will not be making any further distinction between them in this chapter. We will discuss how, where, and when to place your stops. You will need to decide whether those will be hard or soft, depending on your level of expertise.

1 comment:

juan said...

This is a great blog!!! glad I found it..….very educational…thank you…I will put it on my favorites list.. I also learned a lot about trading strategies from 3 other great books. Hedge Fund Trading Secrets Revealed..by Robert Dorfman..and Confessions of a Street Addict of course by Jim Cramer..written before he got really famous.and Richard ARMS..STOP AND MAKE MONEY….all 3 are riveting and very informative. You should check them out if you like reading behind the scenes stuff about hedge fund and what methods they use to make money.