THE GREATEST SECRET OF THE FUTURES BUSINESS IS THE "LIMIT" MOVE.
We all know that the broker will solicit a stop order when the customer places an order.
Many brokers insist that you place a sell stop order when you buy, and a buy stop when you sell as a condition of taking
your order. Do you know why they request a stop order?
WHAT IS A STOP LOSS ORDER?
A Stop loss order is an order to buy or sell a commodity at a specific price. The stop order is converted into a market
order when the specified price is attained. You place a sell stop order for March Gold at $400.00. Should the price of March
Gold go to $400.00 or less, the stop order would automatically convert to a market order, to sell X number of contracts at
$400.00. Buy stop orders are the reverse.
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HOW ARE THEY USED?
Theoretically, stop orders are a way of controlling risk. Should you buy March Gold at $440.00,
a sell stop order at $400.00 could limit your risk to $40.00. When you are short the market, a buy stop order goes above
the current price. The stop order is converted to a market order if the price is attained.
DO STOP LOSS ORDERS LIMIT RISK? ABSOLUTELY, POSITIVELY, MAYBE!
There are a number of problems with stop loss orders.
The most serious problem is the locked-limit situation. When a market locks limit, little or no trading occurs The exchange
fills orders in the order received. A stop loss order is first converted to a market order. Then the market order is put into
the queue. Should a series of limit days develop, and your market order is at , or near the bottom of the order queue, pain
is in the forecast.
Bruce Babcock states the following about locked-limit moves:
The commodity markets are notorious for making locked-limit moves where the trader is stuck in his losing position. The
market can go against him for days while he must helplessly watch his capital disappearing. This is certainly a reality, but
the trader is not helpless to decrease the risk of it happening to him. Pay attention to the risk of surprise events such
as crop reports, freezes, floods, currency interventions and wars. Most of the time there is some manifestation of the potential.
Don't overtrade in markets where these kinds of events are possible.
The Disclosure Document of
Meyer Capital Management makes the following statements:
IF YOU PURCHASE OR SELL A COMMODITY FUTURE OR SELL A COMMODITY OPTION, YOU MAY SUSTAIN A TOTAL LOSS OF THE INITIAL MARGIN
FUNDS AND ADDITIONAL FUNDS THAT YOU DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR POSITION. IF THE MARKET MOVES AGAINST
YOUR POSITION, YOU MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT
NOTICE, IN ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE REQUIRED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION
MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY RESULTING DEFICIT IN YOUR ACCOUNT.
UNDER CERTAIN MARKET CONDITIONS, YOU MAY FIND IT DIFFICULT OR IMPOSSIBLE TO LIQUIDATE A POSITION. THIS CAN OCCUR, FOR EXAMPLE,
WHEN THE MARKET MAKES A "LIMIT MOVE".
THE PLACEMENT OF CONTINGENT ORDERS BY YOU OR YOUR TRADING ADVISOR, SUCH AS A "STOP-LOSS" OR "STOP-LIMIT", WILL NOT NECESSARILY
LIMIT YOUR LOSSES TO THE INTENDED AMOUNTS, SINCE MARKET CONDITIONS MAY MAKE IT IMPOSSIBLE TO EXECUTE SUCH ORDERS.
A "SPREAD" POSITION MAY NOT BE LESS RISKY THAN A SIMPLE "LONG" OR "SHORT" POSITION.
Dennis P. Stahr gives this description:
- Limit Move... "Lock Limit". A limit move is a move in the price of a commodity to the
amount allowed by the Exchange on which it trades. Many futures contracts have limits, and many do not. You had best know
about the possibilities when you trade a contract. Take the soybeans for example. There is a 30 cent trading limit on the
beans. The limit will expand under certain conditions, but let's concentrate on the basics. With the right (or wrong) input,
the price of soybeans could go up or down 30 cents in a matter of seconds. What does this mean to you? Well, assume you bought
one soybeans contract and had intended to risk about $500 (10 cents x the contract size of 5,000 bushels), and you placed
a stop-loss order 10 cents below your entry point. If the price moves down 10 cents, you will sell the contract and take the
loss. Now assume that some information hits the market about this being the best crop in decades. Chances are the price will
drop... and very quickly. If the price dropped 30 cents so quickly that it went through your order to sell so fast that it
hadn't yet been filled, you are literally stuck in your position. The price is now $1,500 against you, (30 cents x 5,000 bushels)
and you CANNOT get out. Remember, to get out you must SELL. If there is nobody willing to pay the current price, (thinking
it may still go lower) your order can't be filled. You must say your prayers before the market opens tomorrow because if the
price goes limit-down on you tomorrow you may still not be able to exit the position. If the limits have expanded to 45 cents,
and they probably did, you are now stuck in the position with a current loss of $3,750. See, I keep telling you to KNOW the
markets you trade. Be sure to call with any questions.
ide Stoneman
Tracy Pride n
Tracy Pride Stoneman explains it this way:
Commodities have limit moves. That’s the maximum daily amount a commodity can move in price within a given day. On
its face, this might sound conservative; stocks don’t have limits and can move up or down limitlessly. One of the reasons
for a limit on commodities is because commodities are heavily margined. It is possible to lose great sums in a matter of days
despite the daily limit move, because if the commodity moves the limit, there’s an excellent chance that you can’t
make a trade to cut your losses. If the commodity goes "lock limit" for 3 days or more, you may see yourself losing vast sums
with no way to get out.
WHY ARE STOP LOSS ORDERS SO POPULAR IF THEY DON’T WORK WELL?
Litigation is rampant in the investment world, as the distraught investors desperately seek a way out of their dilemmas.
Everybody claims to be a "victim" in the investment world!
We must remember that 90 percent or more of all investors lose eventually. The commodities markets accelerate this process
by their price volatility. Phenomenon such as locked-limit price moves can quickly create massive losses. There is probably
little difference in the actual success rates of different classes of investments, but the commodities markets dramatically
speed up the culling process.
The brokerage industry appears prudent and concerned if they constantly inform the investor that they should have a stop
loss order placed for protection. The brokers, the CFTC, and the legal specialists know that stop loss orders don’t
work However, they do assuage the" victims", and later become a great defense in the lawsuits that will come.
Brokers have adapted to this stop loss order defense strategy brilliantly. They have managed to turn stop loss orders into
a profit making technique. By suggesting very close stops, they assure a large increase in commissions prior to the locked-limit
market that wipes out your capital. Some brokers even recommend day trading only, guaranteeing a massive commission bill for
the investor"
Ironically, the technique of closing your trades at the end of every trading session, and reentering in the morning, does
not guarantee that you won’t be caught by a locked-limit move. However, it does increase your commissions dramatically!
Another "secret" is fading the stops. Most traders and brokers know where the public has placed their stop orders. They
push the market to the stop order levels, and place their trades as the stops go off. This allows them to buy and sell at
better prices than they could achieve were the stop orders not present. Yes, they are buying when your sell stops are going
off, and selling when your buy stops are going off. This occurs because the public places their stops too close to the current
price levels.
We need to point out that the brokerage industry is not the cause of this orwellian doublespeak. The public persists in
believing that they can achieve prosperity by investing with no knowledge, and no work on their part (speculating). The public’s
relentless pursuit of the unearned, coupled with the politician's need for reelection, has created this situation.
SUMMARY
The obvious conclusion is that stop orders are a poor way to protect your equity (capital). What is the investor (trader)
to do? Hint! The obvious conclusion is wrong
The first fact of trading is that one must Know the real trend! That means that the investor must Know the market they
are investing in. There is a world of difference in knowing About a market, and KNOWING a market.
Most financial debacles happen to people who violate the true trend principles of the particular commodity they invested
in. Each commodity has its own nature. We must respect this fact to be successful! Does the successful copper fabricator invest
in pork bellies? Does the successful grain elevator operator invest in silver? Did J. R. Simplot (the potato king) own a lot
of high tech stocks in 2000? Invest in what You Know!
Another "truth" is that stop orders should placed at points of trend change.Points picked for money management don’t
work! This fallacy has led to most of the unnecessary losses and commission charges that trader's experience.
The real conclusion of this study is that one must Know the market, Know the trend of that market, and Know not to listen
to people who merely "Appear" to know more than you do. Appearances can be deceiving!
FORGET THE DRAMA! TRADE WITH THE TREND, AND PROSPER!
Wayne N. Krautkramer onlypill@cox.net
https://onlypill.tripod.com/factsthebrokersandfinancialreporterswonttellyou
