Small Stops Percentages Are Always Better
As they offer better Risk Reward
First let’s understand how the Indian and American stock markets are. Let's see how many 20% movers in a week we get in both of the markets to compare swing opportunities we get as a market participant so that we can understand better why it’s absolutely necessary to trade with small SL% especially in India.
Note: In image 2 and 3 the scanner filters are very basic without any liquidity criteria.
From the above 1st image you can see that even though both major indices moved more or less the same percentage, it's 5% more gains in the US market to be precise from bottom considering recent turmoil due to tariffs. And from the 2nd and 3rd image you can see that the opportunity in the US market is much larger than what we get in India, which is 92 tickers doing 20% in a week and 327 tickers in the US. This is because of multiple reasons like liquidity, number of stocks listed etc but that does not matter. The fact that the US market has much opportunity is what we have to agree upon. This holds good in any market condition and any magnitude move, it’s just a fact & common sense.
Now let us add one liquidity filter to the Indian scanner and let’s see the number of outputs we get. After running it, if you see it’s just 32; A simple volume filter dropped the number of scanner output to one third of original output.
Now with this in mind, just imagine the risk reward you will get if you're trading with like 3% or 4% stops. Anyways Its dam is too low. That is if you keep 3% SL and stock moves 20% that is like almost 7R but not 7R, but will you close everything at exactly 7R? answer is no mostly, so the actual gain will be much less, it will be more like 4 or 5R. Now the same thing if you take with 2% SL that is just 1% reduction results in 10R and there is high probability you take home at least 6 or 7R right. Therefore, low SL% give better risk reward keeping everything else the same.
Btw if you're thinking, considering 20% move and doing calculation is misleading or a scam then do one thing immediately. Ask yourself how many trades in the last 1 yr you have caught more than 20% in a stock, out of the total number of trades you have taken. Stocks moving more than 20%, its percentage contribution is and will be in single digit. Here I am not talking about PF impact, instead it’s about the probability of you getting in a 20% plus mover stock. According to me it will be less than 5% of the total number of trades. So, for better understanding I have chosen 20%.
Let’s consider the ADR (average daily range %) of different stocks, can we roughly say that large cap stocks have low ADR compared to small cap stocks? Answer is Yes, because volatility in large cap stocks is much lesser than small cap. That means, can we keep low SL% in large cap then small cap right. Because you need a small room to move around for a large cap! From this can we conclude that or roughly say SL% is usually the function of ADR or volatility of the stock? Answer is yes.
So, in a large cap you can get away with much SL%, let’s say 1% SL or even lesser sometimes. And for example, if a large cap, some random stock moves 10% then your RR will be 10R. This is the reason you prefer low ADR stocks then high ADR as they offer high RR because of the SL% we can keep. (More on this in my earlier ADR blog).
Finally, just because you will get a good RR with low SL% you can’t just keep small SL from tomorrow. But A thing to work upon. If you're keeping more than 2% for swing trading, then there is scope for improvement and remember SL should be a function of volatility of the stock that is lower the volatility lower should be the SL% and vice versa.
Summary,
The probability of catching 20% plus mover as a swing trader is less in India then compared to the US because of the number of opportunities we have.
That magnitude of moves let’s say 10% moves are easy to find and catch then 20% plus moves here.
Small SL% offer better risk reward not always but most of the time.
In large cap stocks you can keep much lower SL% then small cap because of low volatility they possess. And there is no problem of liquidity here.
When SL% decreases, position size automatically increases and vice versa is true. This coupled with high win rate then high position size works in your favour else it backfires.
SL% should be the function of volatility of the stock.
Nice observation 👀