NOTE: In NeuroShell Trader, open the chart named “Example 21 – Trailing Stop” which is the basis for following example:

In this example we demonstrate how to enter trailing stops in order to protect position profit. However, we also explore the tradeoff that can occur with stops.

We have loaded several stocks into our chart and inserted a simple crossover trading strategy for long positions only. We then inserted a protective trailing stop so that our position will be exited if the price drops 3% below the best price so far in the position. Then we plotted the position drawdown for the trading strategy in cyan.

Next we copied the same Trading Strategy to create Trading Strategy #2. In Trading Strategy #2 we removed the trailing stop, and again plotted the position drawdown, this time in red.

Here are some things to notice:

1. The Trading Strategy with protective stop had in general lower drawdowns than Trading Strategy 2 as you would expect.

2. The Trading Strategy with protective stop made an average of 2.1% annualized return on trades over all stocks during the period, while Trading Strategy #2 made an average of 5.1%.

You can see the tradeoff in using stops. Sometimes they prevent you from disaster (e.g. Boeing March 29, 2008), but sometimes the market will “stop out” panicked traders so that the professionals can get a lower price when they want to buy (e.g. Boeing June 23, 2009).

NeuroShell will optimize your stop levels for you to hopefully avoid stops that are too tight. On the other hand, only you know your pain limit, so we sometimes advise NOT to optimize stops into your system, because they may exceed your pain limit in order to maximize profit. It is also possible that a stop will become an integral part of your trading system, rather than the insurance it should be. You might be better off perfecting better exit conditions. You will have to decide for yourself if you want NeuroShell to help you with stops, or whether you just want to keep them between you and your broker.

This example was NOT optimized. We leave that as an exercise.

One final note. The protective stops in the category “Trading Strategy: Protective Stops” are not the only ones you can use, and not all of those in that category are “trailing” either. The category “Trading Strategy: Exit Signals” has some good stops that should be used as exit conditions. Furthermore, you can create you own stop levels with indicators that compute price levels, although that may be something you wait to try until you are pretty well versed with NeuroShell.