Gamblers and Traders

Stop loss orders, Racehorses and Gold

Betting on Racehorses

Many years ago in another life I was a large breeder of thoroughbred race horses. I had horse studs in Wagga Wagga, NSW and Samsonvale in Queensland (find them on a map). My home stud was called St Jude’s Wood and you will of course know that St Jude is the patron saint of hopeless causes. This I thought was apt for a big time foray into the horse breeding world. I bred these little darlings and raced them from Melbourne in the south to Brisbane in the north to New Zealand in the east. In the course of this life which involved being at the track at 4AM to train them, I went to the races 3 days a week and was a decent punter.

Way back in 1978, the year Scomeld was Champion 3yo filly of Australia and won the VRC Oakes Stakes at Flemington, Australasia’s premiere race for fillies I had ,000 on her with the bookies to win. To put that in perspective, that was a bit more than the cost of a nice 4br house in Brisbane’s best suburb Ascot, where I lived. In modern day terms that is about .5 million. And that wasn’t by any means my biggest bet of that year, but it is the one that I remember most clearly for a number of reasons.

As a seasoned punter I had got used to the calamities that lie in wait for the unwary or the plain unlucky. Your horse misses the jump, gets pocketed and can’t get out for the run, the girth breaks, the bridle snaps, the bit comes apart or the jockey just isn’t on the job. With fillies there are more problems that accompany the fairer sex.

On a sunny Saturday afternoon at Doomben race track in Brisbane some time back in the 70s I saddled up a big rangy colt called Rorke’s Drift (see my article for Financial Sense of 16th May 2008 to understand). It must have been during the Winter Carnival when all the gun jockeys travel north for the sunshine, because I had Peter Cook a famous Sydney jockey engaged to ride my colt. Rorke’s Drift on that day was as good as a good thing can be ergo he was unbeatable. He was classes above the local opposition, a Derby colt in the making, had drawn a good barrier, had the going to suit him (it’s all grass track racing in Australia-not dirt) and was to be ridden by the then premiere jockey.

The bookies opened him short but not short enough. I waded through the betting ring taking 7/4, 6/4 then evens. As the gates opened Cook had him quickly away and perfectly positioned in third place on the rails, travelling half pace. The race was as good as over when they had gone four furlongs.

Then he fell.

Horse and jockey were OK and as we saw on the patrol film afterwards, he had been travelling a bit too well and got up on the heels of the horse in front. These things happen in racing and in life. Even the best of good things get beaten. You recall that the mighty racehorse Ajax was beaten by Spear Chief in the 1939 Rawson Stakes when sent out by punters at 40/1 ON. That means you would have got in winnings for every you had on, had he won!

So no big deal. Good things get beaten and punters lose their money. That is the game. But punters aren’t allowed stops. Once the race starts that is it. Win or lose you are powerless to influence the outcome. If your horse misses the start by 10 lengths or more as Ajax did when he got his head caught in the starting tapes that preceded modern starting stalls the punter has done his money cold and can only watch the race unfold with no chance at all.

Very good punters do more work than most traders in honing their selections. A pro punter will handicap fields by weight, speed ratings and track bias. They will have detailed records of past performance. They will watch race patrol films to see what sort of a trip each horse had in its recent runs. They will adjust their ratings for any incidents that happened during the last race and for any track bias. Yes, tracks have biases. In some track conditions, front runners near the rail are favoured, on others, swoopers coming from behind are favoured; some horses love wet tracks; others will fall over if you don’t clean out their box promptly!

How will the track ride today; what are the true track conditions; who will ride and is this an improvement; what barrier is drawn and will this gate suit; where is the pace and how will different runners be suited. Some horses like to run on the pace. Others particularly on the grass are come from behind horses. In fact the bias to front runners on dirt is reversed on grass. How has the track work been. Did the touts get the right horse or mistake it for a stable mate. Did the clockers even see the workouts. In Australia and New Zealand, horses work out at a variety of tracks including some private tracks where only insiders will know the class of the workout. All of these conditions and a hundred more must be accounted for.

True race handicapping at the elite level is considerably more complex than trading.

But having made your selections and placed your bets you are powerless. Your money then rides on the whims of fate.

Stop Loss Orders

Now imagine if punters were allowed stop loss orders! What a thought. Your horse misses the start? Take your stops to market and recover something. At the 3 furlong pole your horse is a back marker on a track with a front running bias-take your stops to market and get out. Better still your horse is nicely clear at the turn and the field is not gaining-move your stops to break even and now you can’t lose. What a thought. There wouldn’t be a bookie left standing.

Strangely whilst there is endless literature and programs on trading there is little material on stop loss placement and what is available is not always correct. There are many places to place your stops and just as many ideas on how to handle stops during a trade. We don’t have room to encompass all the alternatives so let’s just deal with the basics. Most of the alternates are simply variations on a theme although we will differentiate here between stops on entry and stops during the trade.

Being an Attorney, my approach to stop loss placement is linear and logical. I have only two rules so we can simplify their application greatly.

Needham’s Stop Loss Rules

Rule 1: The stop loss on entry goes at the point where the trade will fail.

Rule 2: The definition of a winning trade is one where I can properly move my stop to break even.

And that’s it. What could be more simple.

The two most basic entries into a trade are an order on stop or an order on limit. For a stop order we want to see momentum. I like to do this with a stoch signal. I am not so much interested in what the stoch tells me as what it tells others, so by using a stop entry with a stoch signal I have some surety that others will support the move. Remember there is little discrete information in charts apart from the Danielcode numbers. 90% of what you can see, others see also.

Entries on Stop

This is a 240 minute chart of the trader’s favourite EUR-JPY. Let us assume for the purpose of this exercise that we have completed our analysis from our preferred time frame, in this case the daily chart and we are looking for a sell entry. We now go down to the shorter time frame. For a stop entry with the stochastic signal we are interested in the first cross of the stoch which comes on the bar in the first red rectangle marked S1. A correct stoch entry would have us selling the low of that bar minus a few ticks to create a buffer. (Yes I know that forex traders like to speak of “pips” but I am older and old fashioned and always thought pips were something that came in oranges. A tick by universal definition is the smallest unit that a security can move so you will know of what I speak.) In forex which we are using as an example here, we don’t have a central exchange so each trading platform creates its own prices and whilst they largely accord, some are systemically more volatile than others for the obvious reason although all deny that it happens on their particular platform. To overcome this inherent pricing flaw we always allow a buffer of a few ticks between the indicated low on our particular data set and our order. To make that clearer, subtract 5 or 6 ticks from the low of the bar which has setup your entry (hence “setup” bar).

On this chart, a trader trading without the Danielcode price levels would have sold let’s say 5 ticks below S1 at 169.28 and would have been filled short on the next bar. Where does the stop loss order on entry go? At the point where the trade fails. On this entry we think the stoch is indicating a high so if the market makes a high above the setup bar we are wrong and we want to be out of the trade.

It’s that simple. You can wish and hope and “give it room” if you like, but if your analysis said this was a likely top and it makes a new high you are wrong; and if you are wrong you want to be out of the trade. That’s what stops are for sport.

If you have managed your risk correctly, about which more later, being stopped is no big deal. We are only looking at a 4 hour chart so there is nothing to be learned except that we were wrong. We continue to track this market and the next bar in a red rectangle, this time marked S2 is still giving us a sell on the stoch so we place the order 5 ticks below that bar at 168.74 on stop and it is not filled.

The next bar, this time in a blue rectangle causes the stoch to cross back up to the buy position (stoch K is above stoch D), but we know that if the market trades below the S2 bar the stoch will go negative again so we leave the sell order at 168.74. The simplest way to prove that the stoch will go negative at this price is to use the Genesis “what if” function where you can create future bars of your choice and see their impact on the indicators.

Now we are short when the market trades through 168.74. Where does the stop on entry go? At the point where the trade will fail. Again we think the bar in the blue box is the high and so a trade above the high would mean we are wrong so that’s where the stop goes, a few ticks above the high.

I know this is where all the stops are and occasionally these levels are taken out and the trade then moves away. But if your analysis is right that doesn’t happen often. If you don’t put your stop there where will you put it? Farther away? You can but it is not logical and trading is overwhelmingly an exercise in logic.

Look again at the above chart and you will see a blue line at 169.74. That is the nearest Daniel number in the operating sequence. We know that 85% of market turns on the daily chart come at or near DC numbers. We can define “near” as 40 ticks in forex. Some clients use an even smaller variance. I have a client who lives in Melbourne, Australia who wants to see a variance of no more than 12 ticks on the daily setup bar before considering a trade. In any event, the tighter you set the variance, the fewer trades you will have but your win percent will improve commensurately.

So what we are doing with this process is layering different probabilities from different parameters. In our present example we had two valid stoch entries from the bars in the red rectangle. If we add the requirement that the high of our setup bar must be within 40 ticks of the nearest DC number we are left with only one possible entry as that condition is not satisfied until the bar in the blue box is completed.

You will observe that at the time we create the sell order we know exactly where the stop will go and the difference between our entry price and the stop is the notional “risk”. Remember this; we will need it later.

Entries on Limit

The alternate to entering on a stop is the limit entry. In this case we determine the overall trend from a slower indicator and we look to enter in the direction of the trend from a retracement.

In the above weekly chart of EUR-JPY we can see from the chart and the MACD study that a strong uptrend was in force from early April to late May 2008. That is the signal for us to buy pullbacks. To buy pullbacks, the daily stoch will be too slow so we go to a shorter time frame. In this case a 720 minute or 12 hour chart. The numbers on the 720m chart below are Daniel sequence retracements. We have the same 5,3,3 fast stoch but we have halved the timeframe so the stoch is now twice as fast. We are here looking for two things to happen simultaneously. Firstly we are looking for the daily chart to pullback and stop at a recognised DC retracement and secondly we want to see the fast stoch in the oversold position. We are not waiting for a stochastic cross in this instance. Stochastics like almost all other studies are lagging indicators, so we need to anticipate the stoch for this entry.

There are a number of entry methods here that will be suitable to your temperament and trading plan. An aggressive trader would have their buy on limit order 20 ticks or so above the DC retracement and their stop 20 or so ticks below the DC number. Again you know your risk (order minus stop loss) before the order is placed. A more conservative trader will want to see the turn happening by seeing a higher bar to pull them into the trade after the conditions are fulfilled. Four of the five retracements on this chart meet our criteria.

You can reduce the size of the stops by going down to lower time frames still. I know many trade off 10 minute charts or even shorter time frames. For me that is just too frenetic but it is whatever suits your trading temperament. The technique is the same.

Remember that the shorter the time frame chart you use, the earlier you will enter but the number of false signals is always in proportion to the time frame you use, so the early bird in trading may get the worm but is sure to get more false signals.

What time frame suits you is just a matter of temperament and opportunity. A pro trader, particularly a young pro trader will use charts of a very short time frame and be happy to have a number of false entries with small stops. A part time trader who wants to place their orders and go to work will use the Danielcode T.03 signals and trade from daily bars. In this case the stop on entry will be much bigger but that doesn’t matter as I will show you under the “Risk” section of this article.

Running Stops

Once the trade has moved in your favour, you will want to progressively move your stops to reduce and eventually eliminate the risk. To do this you can use an arbitrary measure, a chart pattern or an indicator.

An arbitrary measure just says when the market has moved X units I can move my stop to break even.

A chart pattern stop says that if the trend is up we can safely move our stops below each successive swing.

To use an indicator, you would put your stop below a Keltner Channel, a moving average or some other objective indicator.

For me, the objective is always to get the stop to break even. That is my definition of a winning trade. I have eliminated the risk and can now exit on a time measure (Larry Williams’ first profitable opening) or a measured move.


By knowing where our stop loss order on entry will be, before we place the trade we can calculate our notional risk. I say notional because there are always other forces such as market liquidity, slippage and brokerage that will affect the total risk.

Because we can precisely measure the notional risk before we place the order, we can adjust our risk by altering our position size. So if our trading plan calls for us to risk 2% on each entry we determine what that percentage is in dollar terms and we divide the dollar value of the calculated notional risk into that figure. That determines how many contracts you can take on each trade. For example, on a ,000 account and a trading plan that has 2% as our risk on entry, we will risk 00 on the initial risk. If the calculated risk (entry +- entry stop) is 0 you would take two contracts. If 00 risk then only one.

The prudent risk to guide your trading plan is a function of the win percentage of your trading program. The higher the win %, the higher the percentage of your account you can prudently risk, always of course within limits.

Always be cognizant of the law of small numbers. If you are looking at a run of 70 or so trades, that will not be nearly representative of the universe of chance. You would need 700 trades to see a definitive pattern. As a rule of thumb always square, and be prepared for the square of your worst result to come true. So if your trading results show a worst run of three consecutive losses, it is an even money chance (1/1) that a losing sequence of nine will at some stage appear. If four then figure on sixteen. That is why the risk that most institutions accept on trading accounts is 1-2%

Learn from losing trades

I tell my students that we learn nothing from winning trades. Apart from patting ourselves on the backs and enjoying the euphoria that only traders and punters know, nothing is learned from winning trades.

Losers however are our school. I obsess over losers for days and weeks. That is how we learn.

Below is the US Dollar Index chart. Two failed trades, both on valid sell signals are marked in red rectangles. They happened on 07/25 and 07/31. These failed trades allowed me to alert Financial Sense readers, and in considerably more detail my subscribers, that there was unusual strength in DX. If you weren’t long this market after 07/31 you certainly had no business shorting it as many did.

For the same reason Gold’s big hit this week was no surprise. Dollar up; Gold down. With the prevailing inverse correlation, I have been preaching this mantra since March.

Update on Gold

Last week the Gold and HUI binomial trend charts that are available free for Financial Sense readers at the Danielcode Online all flipped onto a confirmed sell signal and the result was the big move down in Gold that we have seen as the physical finally caught up with the HUI which has maintained consistent sell signals since March. You will have noticed that the stronger monthly signal on Gold has stubbornly remained on a sell since March also, so this fast move down was no surprise although the speed and the capitulation were. Someone of size had to get out in a hurry!

This week Comex Gold has capitulated into its Daniel number support at 807.40. More importantly the black DC number at 802.10 is the last level of Danielcode support for the major swing which marked the final fast leg up for Gold from November 2007. The black Daniel numbers have special significance as they have a marvellous record of holding markets or signaling an end to any support within the operative swing. We have studied the same black line in large equity indices lately and seen how they exert a huge influence on all markets. This particular Daniel retracement works on a close only basis, so a weekly close below 802.10 will signal much lower prices whilst a reversal at or near this number will signal at least an intermediate low.

Notice that the black line which was created on this chart in late March is now occupying exactly the same number as the equal range measurement of the two down legs. For this to happen. the May rally had to top out at 989.60 exactly. This it did. How, you should ask can a fractal of a previous swing exactly match the commonly seen “equal range” happenstance with such precision, and we are talking about precision to the tick, not a few points?

If you understand this you will not be surprised that the Danielcode is assisting competent traders all over the world. Scott M from San Diego, CA who is shortly visiting Down Under to renew old acquaintances is a part time trader. He wrote today:

Trading with the DC has been great as I have more than doubled my account from 11,500 to almost 27,000 in four months.

Now that is a really nice annualised rate.

The Gold Trend charts for FSO readers are updated every Monday before the US open and they continue to give the best signals for this market. Remember that almost all chart studies are lagging indicators so price moves first and indicators follow. Now is a time to be especially watchful for new Gold and HUI signals generated by price.

Currency Snapshots

The “China will save us” mantra is starting to look a little thin as the realisation gradually dawns that global linkage means the lands Down Under will not be immune to the fun that is coming down the track. Neville Chamberlain's legacy is marked by his policy of appeasement which culminated with his signing of the Munich Agreement in 1938, conceding part of Czechoslovakia to Hitler. The action of central banks in shielding banks and their camp followers from the consequences of their gambling addiction is also appeasement. Those who learn not from history are destined to repeat its mistakes, a condition that appears chronic amongst economists, real estate agents, investment bankers and central bankers in particular.

The lesson from history is that appeasement doesn’t mean the crocodile won’t eat you; it merely means the crocodile will eat you last. And so it is in Australia and New Zealand where the penny is finally dropping at least with foreign investors who are getting out in droves.

This chart is the Aussie Dollar giving up 12.5c in four weeks. Of course a lower AUD makes the game even better for exporters but capital constraints may be the ultimate consequence. Perhaps this realisation is partly responsible for the more bearish posture of the HUI index which has given up all of its gains this year and is now down to June 2006 price levels.

For the Cognoscenti the bay or brown horse in the top photo is the mighty Tulloch, the best grass track horse of modern times and together with Kingston Town the best racehorses I had the pleasure of seeing. The big Chestnut is of course the incomparable Secretariat, the best dirt horse of modern times.

This photo is of Kingston Town winning the 1982 George Main Stakes in Sydney. Kingston Town remains the only horse to have ever won 3 successive WS Cox Plates (1980, 1981, 1982). From 25 starts in Sydney, Kingston Town won 22. He was ridden to victory by Malcolm Johnston 25 times, by Peter Cook and John Duggan twice and by Ron Quinton once. More pertinently Johnston who was a media favourite (media, other than in UK never quite “get it” that the horse carries the jockey not vice versa) was a smart ass on his good days and an idiot on the rest. He slaughtered Kingston Town when he was asked to carry 62kg in Gurners Lane’s 1982 Melbourne Cup. For the rest of the time the horse was good enough to win despite the jockey.

I had Kingston Town at my St Jude’s Wood stud for a month at the end of the Queensland winter carnival for a spell (ease up) in his 3yo year. He was a lovely horse to look after but a fearsome wind sucker in his box. Both Tulloch and Kingston Town were trained by Tommy Smith and Tommy did rank Kingston Town in Tulloch’s class but he was the only one. Tulloch had a mystery scouring illness at the end of his 3yo year that almost killed him and he was 15 months recuperating. My friend the great horse vet Percy Sykes eventually cured him by feeding him mud and dung balls to restore the natural enzymes in his stomach. Percy had learned this trick whilst a very young trainee vet with the British Army in India where his charges included the pack train Elephants! Life is strange isn’t it. But that’s a story for another day. Tommy always said that great as Tulloch was, he was never quite the same after that illness.

Trading, like the breeding and training of champion racehorses is partly skill and partly art. The better your skill becomes, the more you will see the art. I invite you to visit the Danielcode Online and view the free charts and our market reports. The Danielcode is more than science or art. It is the code of all life and all markets.

Copyright © 2008 John Needham

About the Author

Lawyer and Financial Consultant
jneedham [at] thedanielcode [dot] com ()