Paul Tudor Jones is a famous billionaire hedge fund manager. In an interview he gave to Jack Schwager and later published in the book “Market Wizards”, Tudor Jones reveals that he “doesn’t just use a price stop, but also a time stop”.
Beginner traders are taught to use a stop loss to avoid big losses and protect their capital. A stop loss is an order to buy or sell a specific instrument once the price reaches a certain limit. If you’re selling your stop loss will be a buy order and if you’re buying your stop loss will be a sell order.
Paul’s concept is fairly simple as he explains in the book: “With a time stop, you can set a specific time frame for a move to happen and when it doesn’t, you cut your position no matter if you’re taking a loss or a small profit. The instrument is not acting the way as you expected, so there is no reason to keep your money in it.”
Let’s see an example of a recent trade. Friday’s NFP report was a good one if you ignore the headline miss and focus more on the details which highlight a tight labour market with wages up and unemployment rate down. You could take a short trade on Gold and place a stop loss above the recent swing point.
After some time though you could see that the trade wasn’t playing out as you expected, and the price action became messy and rangebound. If you expected the price to fall, as such good NFP report puts more pressure on the Fed to act swiftly, then why should you keep your money at risk if it’s not following your views? Just cut it for a fraction of the original projected loss and wait the next opportunity.
If you would have waited for the price to go your way in hope you would have taken a full loss as you can see in the chart above. Capital preservation should be your priority in trading and this risk management tip can help you with that.
This article was written by Giuseppe Dellamotta.
