Scientific Method of Setting Optimal Stop Loss Level in Trading System

Risk management is the core of trading technology, and the setting of stop loss is the top priority of risk management, so it occupies a very critical position in the entire trading technology system. Whether the stop loss is set reasonably directly affects the performance of the trading system and even determines the success or failure of the transaction.

In foreign exchange trading, the setting of stop loss levels is particularly critical because the exchange rate fluctuates widely and the long and short conversions are also very fast. If the stop loss range is set too wide, the losses caused by each stop loss may be too large, resulting in unnecessary consumption of funds; but if the stop loss range is set too narrow, it is easy to trigger stops frequently, which may not only miss part of the profit opportunities, but more importantly, it will reduce the winning rate of the system and affect the mood and confidence of traders.

The stop loss level can usually be set subjectively based on trading experience and capital risk tolerance. This is a more common practice, but this method is more subjective. In fact, there is an optimal stop loss level, and it can be found through some uncomplicated statistical analysis. For a trading system, as the stop loss value changes, the profit level will also change.

Among these stop loss values, there must be a best value that can maximize the profit of the trading system, but many people do not notice this. If this optimal stop loss value is not found, potential profits will continue to be lost during the trading process, which will accumulate over time to a considerable amount. For example, some professional institutions such asPepperstoneIt is also recommended that traders use historical data backtesting to optimize stop-loss parameters, thus making the system performance more stable.

I selected four values: 40, 30, 25, and 20, respectively, as stop loss values. By backtesting the historical data of 2011, I obtained the following comparison table of trading results (see chart). This is the profit and win rate data for the first 11 months of 2011. The initial capital is 3,000 US dollars, and the trading instrument is Australian dollars, each lot is 0.1.

This chart has the following characteristics:

First, from 40 points, 30 points, and 25 points to 20 points, profits initially rose gradually, reaching a peak near 25 points.

Second, the winning rate decreases from 40 points, 30 points, 25 points to 20 points, especially when it decreases from 25 points to 20 points, the winning rate decreases rapidly.

It is very obvious that the optimal stop loss should be around 25 points. The maximum profit of this value in the first 11 months is 3,384 yuan, and the yield has exceeded 110%. At the same time, the winning rate of 25 points is 38%, which is not significantly reduced compared to the winning rate of 40 points and 30 points. This is a very ideal stop loss value. Of course, the optimal value can be further accurate. This value may be 26 points or 23 points, but the precision control is within 5 points. However, it should be noted that this is only one year of test data, and the sample size is small. If you have time, you can collect more historical data to verify.