Research has shown fixed stops-losses tend to hurt performance.
In many cases completely remove any advantage a set of rules may have over dart throwing. Yes, it feels good when a stock keeps moving lower and lower (or higher and higher when short) and a stop gets you out. On the other side, the research, which is backed by up by two decades of test results on many short‐term trading strategies, suggests that stops get hit often and accumulate many, many losses. Few trading strategies can overcome these aggregated losses.
For many traders, stops are a must. Psychologically it allows them to take trades, especially difficult trades but on the whole, the edges you see in strategies are lower when stops are applied to them.
So then how do you get out of a trade if you don’t use a stop loss? QiT uses something called a Dynamic Exit. We don’t set the stop loss at a set percentage or a set number of days. We exit when a particular indicator reaches an exit point. This could be as simple as an exit when the 5-day moving average crosses a 15-day MA, when the MACD crosses down (or up), etc. or when the 2-day RSI hits a predetermined level.
Different exits will give widely different test results. This means the ability to backtest your exit to see which is the most beneficial is a huge advantage over paper-trading your exit strategy overtime and “testing” different exit types. This is where backtesting becomes invaluable.
Here at QiT, we’ve tested many different types of exits and the one we’ve decided on is the Connors RSI.
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