You may see us use the term “mental stop” when we talk about potential trades in futures or stocks that don’t have liquid options markets.
What do we mean by mental stop? It indicates a price point at which we fully intend to exit any given trade.
How do you set a mental stop? Use your broker software to set an alert at a price point you consider your mental stop. If the alert goes off, manually exit the position immediately.
Doesn’t that take away the automation and bring human emotion back into play? Yes, but trading is about discipline and this is a great way to train yourself to be a mechanical trader manually rather than relying on an automated order. Don’t second guess yourself. If the alert goes off, exit the trade.
Why not just use automated stops? The market is efficient, but manipulation still exists. We have been trading for a long time and have learned a very simple lesson about stops…they always hit. We have experienced much lower hit rates with mental stops vs hard stops. We can’t argue with results, so we keep things stop purely mental.
Is there anything else I should know about stops? Yes, regardless if you’re using a mental stop or a hard stop, you should understand that the market knows where the majority of the obvious stops will be placed. Make sure you give your stop some breathing room in conjunction with the obvious level. That will help decrease your hit rate, just be sure the risk reward still makes sense.