In Case Of Emergency: Use Stops

For several weeks now, every time I turn on my computer all I see is winning.

All the time. Without exception.

I know 100%-style robots are built for this, but it's still amazing. I know the worst thing I can feel is overconfidence, but I'm still overconfident.

Do you know what it feels like to wake up every day and see the robots winning? Let me tell you: it doesn't suck.

And every day I wrestle with the voice in the back of my head telling me to drop everything else and trade only these robots.

But I know the dangers. No amount of winning can fully make me forget the downside.

Of course, these robots trade without stoplosses. That's why they win all the time. Without a stop to ruin the party, every trade has a chance to work out profitably. Without a chaperone to pour cold water on a trade idea, every night can be prom night.

Of course, that's what makes these robots so potentially dangerous.

For one, they can lull you into a false sense of security (they've already lulled me).

But more importantly, they can turn against you at any given time (like we talked about last week in the Thursday 2pm webinar).

If you look at any lengthy time period on any 100%-style robot, you'll probably see at least one trade where everything could have gone terribly wrong. There's at least one trade where, if it hadn't closed properly, would have taken down your account. And sometimes the margin of safety comes down to only a pip or two.

The example we talked about last week was on the USDCAD. There was one trade that was closed for a profit on the chart. But if it hadn't closed, the drawdown would have ballooned to margin-call heights.

Well, the trade closed for profit. What's the big deal? The big deal is that there was only one pip of margin. If the spread increased (for any reason) just one pip more than usual, that trade might not have closed and we'd be cooked. To me, that's scary.

Do we have any options? Or do we just have to accept the fact that one scary trade is out there somewhere?

We do have an option: we can use an emergency stop.

What's an emergency stop?

It's a stoploss that's extremely large, large enough that it almost never comes into play. An emergency stop guarantees that one scary trade will never margin-call your whole account. True, if the trade hits the emergency stop, that will be quite a large loss. Your account, however, will still be intact.

While definitely solving the problem of losing it all on one trade, what does an emergency stop do to the overall profitability? It feels like an emergency stop will happen just often enough to take away all of our profits (besides being a big, old-fashioned bummer).

Does an emergency stop ruin profits?

Surprisingly, the answer is no.

I've been working on a portfolio of five Fair Value robots for a while now. First I did the research on how profitable they could be if they won every time with no restrictions. Then I put the emergency stop in. Here's how it turned out.

For total profit, the robots with no stops came out ahead. That makes sense. You make more money if you never take a loss than if you periodically lose a chunk of your account.

For total drawdown, though, the emergency stop portfolio did way better. By putting a limit on how far any currency pair can go (while still giving it room to win almost all the time), the drawdown danger becomes much more manageable. Because of that, it's possible to consider a bigger trade size, which would increase profits.

The easiest way to compare these two types of portfolios is to use the Profit To Drawdown ratio. This simply divides the total amount of profit by the maximum drawdown--the higher the number, the better.

If a robot/portfolio has a profit to drawdown ratio of 2, that means that the robot/portfolio creates twice as much profit as the worst possible scenario. That means it makes $2 profit for every $1 of drawdown.

In short, it doesn't matter if a robot makes more profit than another robot if it also incurs more drawdown.

Using the profit to drawdown ratio, the no stop portfolio comes in at 2.5. The emergency stop portfolio comes in a 2.6.

In other words, if I increased the trade size of the emergency stop portfolio so it equaled the profits of the no stop portfolio, the emergency stop would produce the same amount of money with slightly less drawdown.

However, it's pretty darn close.

So once again it comes down to what you like. Do you like winning every series of trades even if the danger of One Bad Trade is looming somewhere in the darkness?

Or do you like having the security of an emergency stop, even though it's going to potentially wipe out days/weeks of profits when it's hit?

Either way, you'll probably end up at the same spot in the end.

Unless you quit because you don't do what you like.

Choose wisely.