How do stop loss and limit gains work in TradeMachine®?

This instructional video demonstrates how to use stop losses and limit gains with TradeMachine® to improve trading returns by considering stock dynamics.

Stop Losses

A stop-loss is an order placed with a broker to sell a security when it reaches a certain price. This is used to limit an investor's loss on a position. For example, if you own a stock and set a stop-loss at 10% below the purchase price, the stock will be sold if its price drops by 10%. In options trading, stop losses help protect traders from significant losses if the market moves against their position.

How Stop Losses Influence Options Trading:

Risk Management: By setting stop losses, traders can cap their losses and prevent a bad trade from resulting in a significant financial setback.
Strategic Adjustments: Stop losses allow traders to systematically exit losing trades and potentially re-enter at a more favorable position.

Limit Gains:

A limit gain, or take-profit order, is an order to sell a security when it reaches a certain price level, thus locking in profits. For example, if you buy a stock and set a limit gain at 20% above the purchase price, the stock will be sold when its price rises by 20%. In options trading, limit gains help traders secure profits before the market reverses.

How Limit Gains Influence Options Trading:

Profit Assurance: Setting a limit gain ensures that profits are captured once a target price is reached.
Reduction of Market Risk: By securing profits early, traders reduce their exposure to potential adverse market movements.

Conclusion

In options trading, stop losses are used to limit potential losses by selling a position if it reaches a certain price, while limit gains are used to secure profits by selling a position when it reaches a predetermined profit level. Both tools are crucial for effective risk management.

Shows how to implement stop losses in option trading strategies using TradeMachine®, showcasing how understanding the unique stock dynamics of different companies like Apple and Disney can significantly influence trading returns. By applying stop-loss techniques and timing the reopening of positions based on these dynamics, traders can enhance their risk management and potentially achieve higher returns, demonstrating the power of a nuanced approach to option trading.

The mechanics of TradeMachine® are that it uses 15 minutes before the close prices for all entries and exits. Because the backtester uses end of day data, the stops and limits won't be exact. Perhaps the bigger impact is the fact that stocks gap from day to day and that can move the PnL well past the stop and limit setting.

Video Transcript