For the most part, trader’s stops are based on money, ticks, pips or some percentage of their trading account. All of these are money management stops. In this respect, the level selected for the stop should take into consideration your risk tolerance.
However, very few traders use time stops in addition to money management stops. Time stops are trade management stops.
Using a time stop is quite simple. You apply a stop to your intraday positions which has nothing whatsoever to do with price. With a time stop, you decide how much time since entry is enough for your position to have moved in the direction you anticipated.
When you are trading there are two ways to be wrong:
- You can be wrong about direction
- You can be wrong in your timing.
Think about how many times you have entered a position, then saw your money management protective stop get hit for a loss, only to see the market turn around, and go in your desired direction; a most discouraging situation. You were right about the direction it was your timing that was wrong!
The idea behind the use of a time stop is that it has been proven that the longer an intraday trade remains suspended between a profit and a loss the more likely it is that the position will produce a loss.
The use of a time stop goes hand-in-hand with having a defined trading plan. You should have a well-defined setup or entry signal, a definite profit objective, and a money management stop loss. The stop loss can be fixed or trailing, as you prefer.
The question almost always comes up: “How long should I give the trade to materialize before I simply exit?”
The answer is that you make that determination through study and testing of your chosen market and time frame. If you trade in more than one market, then you make the determination for each market and time frame in which you actually trade.
Experience has shown that the best time to get out—win or lose—is when trading slows down while you are still in the position.
What we want to gain by using a time stop is a reason to exit those trades which are hanging around break even, but have are not really going anywhere—doing nothing to encourage us to stay in the trade. Profits are made when there is momentum in the direction of our profit objective. If momentum decreases, simply get out. You will find that some of the time you will exit with a profit and other times with a loss. Either one will be small and inconsequential in the long run.
When a market becomes volatile a time stop may be as little as 1 minute. If volatility is low, you may choose 5 or 10 minutes for the trade to go your way.
Even when using a time frame as long as 60 minutes in a less volatile environment, your time stop is not likely to be more than 30 minutes.
The major objection to the use of time stops is that they can involve a lot of in-and-out trading. It is true that positions are exited even when they are not actually losing money, simply because they have run out of time to materialize. I have no argument against that point, it is valid.
However, experience dictates that sitting in front of a screen hoping that a position reaches your profit objective, more often turns into a loss than into a profit. You certainly don’t want to be holding a position when liquidity dries up, the market suddenly becomes volatile, or you see an entry signal for a trade in the direction adverse, to your current position.
You should become aware of those times when liquidity dries up. Typically, it will be around the lunch hours of the major trading centers. Also be aware of when reports or news releases are scheduled to come out. Ten to fifteen minutes before a report or news release is due to come out, liquidity will dry up as traders wait to see what is in the report.
Keep in mind that although electronic markets are open for extended hours, traders are not willing to trade during all those hours, so liquidity tends to dry up during the hours when a lot of traders are simply asleep. Traders are creatures of habit. They still tend to trade the most during the hours they traded during the years prior to electronic trading.
The use of time stops adds a dimension to your trading that few traders ever employ. If you use them wisely they can definitely improve your trading. Time stops quickly dispatch non-performing positions and reduce the burden carrying a position that is going nowhere.