Why I Don’t Like to Use Stop Losses

The following question comes up often: “What’s your stop loss, Hugh?”

I don’t have one. It’s not that I don’t manage my positions. I do. But I found that using hard stop losses never really worked well for me with options on the SPDR S&P 500 ETF Trust (SPY).

What happened more often than not was that I would be all too frequently stopped out. I realize that was the intent, but I was not netting any real gains in the long term with that approach. It didn’t even matter so much how much my stop was for… 10%, 20% or even 30 and 40%. The stock turned on me, the option lost its value and “POW!! BAM!!, sorry about your luck, Batman!” I lost another one!

Was I really wrong or had I simply not let the option mature to my profit yet?

Then it got worse. Human nature, being what it is, meant that I would continue watching my “had been” option as if it were still mine, only to see it come back into profitability 20 minutes later. Not only did I get hit financially, but now I was emotionally hurt as well. How many times have I thought, “I should have stayed with it!”

You see, you are in a losing position as soon as you buy an option just on the bid/ask spread alone. This is because the delta, the same force that creates great wealth using options, is the same characteristic that enables options to lose their value quickly. It doesn’t take much to wipe out premium, especially if you are trading same-day expirations. There is huge money to be made on zero days to expiration (DTE) contracts, but there is also a great risk of losing it all, too.

I manage my positions by buying enough time to allow my options to breathe. Markets vacillate, often dropping significantly before returning to deliver their gains. By buying time, I am allowing for this fluctuation in the option price.

Secondly, I anticipate longer-term trends, taking into account both fundamental and technical considerations. I analyze the situation with an eye on where the stock may be headed in response to economic news that may influence interest rates. The initial knee-jerk reaction to the positive news, for example, may momentarily spike the stock, but once the media pundits beat it down, SPY usually spends the rest of the day retracing to a major support level.

A stop loss would undoubtedly have taken me out, only to have made money had I lingered on a little longer.

It’s a dilemma, for sure, and some traders swear by it, others swear at it. Many traders I talk to insist on using stops. When asked how it is working out for them, they reiterate similar stories to what I mentioned above.

If you are firm on using stops, then use a trailing stop instead. A hard stop is visible to other traders, including the big players. They can see your prices and easily execute orders to take them out, leaving you in their dust. A trailing stop, however, resides on your computer, not on the market, and only executes your exit trade if/when the price hits your trailing stop. At least you are provided with a little protection in that regard.

Perhaps stop losses work better with some instruments. I found that seasoned traders, those who are better able to control their emotions, fare better in managing their positions without stops.

That said, if you are a newbie, a stop loss may be an appropriate tool as long as you pay attention to your position size. Trade small using stops and, although you may be stopped out more often than you care to know, you may live longer in this space to trade another day. As you gain experience, you may reconsider that approach.

How much should your stop be? That is something we discuss in detail in the Trading Room. A good deal depends on where you expect SPY to go before the end of the day, as well as news announcements, chart patterns, Ahren’s deep dive analysis and how the mainstream media interprets the events of the day.

For that reason, you belong in the Trading Room. If you are familiar with calls and puts, click here to join our famous DayTradeSPY Trading Room. If you are unsure of whether options trading is for you or not, please click here to join our free Sunday night Intro to Trading / Week in Review session at 8 p.m., ET.