Profit targets were found to be helpful, and Stop Losses less so, but can the combination of the two be greater than the sum of the parts?
For this test I create scenarios that include all profit targets and all stop losses from the previous two tests. Targets and Stop losses from 10% to 100% will be used. Ultimately this creates 2700 unique scenarios across the first three months.
Now that we have four input parameters (Delta, Days to Expiration, Profit Targets, and Stop Losses) for every scenario, analyzing the general trends is much harder. Ideally I need a holographic projection to show the data in three dimensions – but the budget here at Option I/O is low, so we will have to make due.
We start by looking at the high-level break down of the tests.
|1 Month||2 Months||3 Months||All|
This are pretty surprising results to me. There was no question that adding stop losses and targets limits should improve the risk for every trade since we saw that in the last two tests. But I thought the combination of the two would help with the over all expected return as well. But what we see is the Front Month trades are resoundingly impacted by adding stops and limits, however the 2nd and 3rd month trades have a definite improvement.
Looking at a heatmap of this data shows more detail.
This data does not mean that any of these trades are necessarily bad trades. This is simply a comparison to the baseline test. The red indicates the trade is worse than holding to expiration based on the Profit Factor. Green is an improvement.
Here are some of the takeaways from this data:
- Front-month trades are heavily impacted until the profit target is ~100%. Even then adding stop losses seem to help some, but not all the trades. And most gains or losses are marginal.
- Almost all CTM trades in the 2-3 month time frame were improved.
- Very low stop losses are stopped out a lot and are generally detrimental to the trade.
Looking at the heatmap in another way (not posted here but in the data file), I see a rough pattern where in the 2-3 month trades, the largest benefit is received by high delta/low target trades though to low delta/high target trades. There seems to be a sweet spot depending on the delta of the trade. You can see in the data that as the delta is decreased the sweet spot moves.
One final point in this section, the largest benefit goes to the CTM trades. This can easily be seen in the following chart. The DiffPF is the improvement in the Profit Factor over the baseline.
With 2700 points, this is also a little hard to read, but this graph shows the general trends based on the delta and month of the trade. Most Delta 10 through 20 trades appear to have a positive expected average. While most with 30 and above do not.
Top 3 Trades for each Month
The following table shows the top three trades (by Profit Factor) for each of the different expiration months.
What is interesting to note is that many of these trades are very close to the baseline test. It’s also interesting to note that all the trade are with a delta of 10. Personally I would have thought that all the top trades for any month would have been slight variations of each other, but two trades stand out as different. The 2nd month 90/40 trade and the 3rd month 30/90 trade.
Top 3 Trades by Trading Style
I thought it would be interesting to also start listing the best trades by style.
(See my previous article about trader styles here.)
Again we see that for Front-month trades, the best scenarios are the same or close to the baseline. The back-month CTM trade however shows there may be an advantage with a 50% target and a 40% stop.
Surprising, Profit Targets and Stop losses do not have a major impact on the front month trades, but they do on the 2nd and 3rd month trades. They reduce the risk in every scenario. There is a sweetspot for the stop loss, but it is dependent on the delta of the trade.