Cumulative frequency distribution average 10-day daily range in coffee
250 750 1250 1750 2250 2750 3250 3750 4250 4750 5250 Range ($)
Figure 3.8 The cumulative frequency distribution of the 10-day average daily range shows that an initial stop of $3,000 or more covers 98.3 percent of all trading ranges.
If you look more closely at Table 3.11, you will see that for some markets, such as gold, sugar, and soybeans, the length of the average losing trade did not decrease much even after adding a stop. This means that the volatility in these markets is not as large as, say, the currency or bond market. An approximate initial stop that will produce an average losing trade length of 10 or 11 days is also shown in Table 3.11. The S&P-500 index futures contract and coffee were the two most volatile markets, followed by cotton, Swiss franc, and the U.S. bond markets. Conversely, gold, sugar, and crude oil were relatively less volatile. Hence, you may find it useful to consider overall market volatility when placing your initial stop.
In summary, you can get a better feel for system performance if you use loose stops with a self-correcting system. If a stop is "tight," then a small change in the stop can affect long-term performance. If a stop is "very loose," then changing the stop will have little effect. As you loosen your initial stop, the profits increase and then change more slowly. This
60 Foundations of System Design
Table 3.11 Effect of initial money management stop on length of average losing trade
| Market | Average Days in Losing Trades (-1,500 stop) | Average Days in Losing Trade (no stop) | Initial Stop Required to Give 10-11 days in Average Losing Trades (variable stop) (S) |
| Coffee | 1,600 | ||
| Copper, high grade | |||
| Cotton | 1,250 | ||
| Crude oil | |||
| Deutsche mark | 1,000 | ||
| Gold, Comex | |||
| Heating oil | |||
| Japanese yen | 1,000 | ||
| Soybeans | |||
| S&P-500 | 2,000 | ||
| Sugar | |||
| Swiss franc | 1,250 | ||
| 10-year T-note | |||
| U.S. bond | 1,250 |
means that once you pass some volatility threshold, increasing the initial stop adds little value.
Another reason to use loose stops is that you cannot properly test stops that are smaller than the daily price range. Ideally, you should base your initial stop on money management guidelines, the maximum adverse excursion of the system, and on market volatility. There are many ways to select an initial stop; once you pick a method, you should use it consistently.