Don’t Blame the Stop Loss

Trader's Mindset

Mar 22

The E-mini futures are arguably the best products available for trading today. The S&P 500 E-mini ES futures is undoubtedly my favorite trading instrument. However, a single contract is probably too large for a mediocre or average trade and trading several lots demands strict discipline.

I think if the S&P 500 E-Micro trades as well as the E-mini then it will be a real game changer for independent traders, like myself– because we won’t have any more excuses for taking too much risk or using poorly chosen dollar-based stop losses.

However, I have learned that if I am getting stopped out on a trade repeatedly then it is usually because my idea simply is not working or the time frame and “context” for the trade is most likely on a longer time frame.

A good indication that a trade is “traded out context” is getting stopped out repeatedly during the day only to find that the trade works beautifully the next day. Of course, in order to hold a trade longer in futures will generally require a larger stop loss. The right sized stop may be too much risk either for our account size or for the quality of the trade idea.

But don’t blame the stop loss because there are solutions to this problem that already exist today! You can express a longer term bias with limited risk using the CME options on futures contracts. In addition, NADEX offers binaries and spread trading products, as well.

You can short or buy the market with a limited risk and no risk of being stopped out! The catch is that if the market zooms straight to your target then you can capture better value with often better risk using futures. Futures also lend themselves to more active trading. It can prove difficult to get the value out of spread trades. Of course, you can trade out of such trades when they do not work or take partial profits. In addition, it may be more difficult to get filled in options.

The key is knowing which product is right for the trade. A decision matrix might look something like the following.

Prefer futures if:

  1. You expect the trade to work immediately.
  2. The trade is shorter term in duration, faster trading is needed, and targets are smaller.
  3. You believe you can capture the reward with acceptable stop loss risk.
  4. You do not have much expectations as to what will happen after you reach your target, you anticipate the market may reverse quickly after reaching target, or if you think the risk of a stop out is low while generally there is more reward to stay in the trade but more difficult to define that reward in terms of duration.

Prefer options on futures or options products, if:

  1. You have a good thesis for a trade but do not anticipate it to work immediately.
  2. The trade is longer term in duration.
  3. You believe that there is a high risk of a stop out or the stop loss risk is too high.
  4. You have anticipation the market will close above or below your spreads at expiry.

Futures are generally better for scalps, short intra-day trades to a defined target, and momentum trades. Options will work better for bigger day trades, swing trades, possibly some types of mean reversion trades, and some types of longer term trades.

With futures trades, you will risk stop losses. Stop losses have “path risk” while options have an “end point” or expiry risk. For options on futures trades, you will be faced with the difficult decision of taking a small partial profit or risking a total loss in order to get better value on your trade.

Another benefit with futures is that if you can get into a winning trade then your profits can multiply. With options trades, you can get a higher reward to risk based on the random probabilities of the market.

The key take away is that being able to structure more types of trades across more products and time frames should enable better trading.

About the Author

The author is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact the author at