To The Moon

While traders are focussed on looking at setups and next trades, elite traders are obsessed with extracting more edges from their system and market. While most traders are taught to focus on risk management, use stop loss, the real shift of a trader comes in finding the edge where potential reward is much higher than the risk you are taking.

Within our team, they have been highly debating the pros and cons of these two methods and the market environment/setup in which either of these methods would benefit the most.

While everyone thinks and is told the main goal of Risk management is only about reducing losses, It is about creating asymmetric R:R outcomes while staying aligned with opportunity.

If you are not familiar with what we are talking about, we are referring to elite traders Jeff Tsun’s 3 stop risk management methodology vs Martin Lukks tight stop methodology.

Let's recap the basics first:

Stop loss = a structured (Prev Day Low, low of 5min Candle etc) or a fixed price away from entry price

Position size = max_loss/(stop_loss_price - entry price)

Profit = position_size x (selling_price - cost_price)

While the goal of both (Jeff's & Martin Lukk's) systems is to get asymmetric reward gap (Convexity Gap) both try solve in two mathematically different ways.

At this point you need to think beyond your stops getting hit and ask three questions:

What is the risk model actually doing?

• Is the system reducing losses through structure

• Is it maximizing winners through precision?

• Does it fit the way I actually trade?

What does it mean for expectancy?

• 3-stop model reduces average loss and smooths the equity curve.

• A tight-stop model accepts more full losses in exchange for larger outlier winners.

• A wider structural stop can tolerate more noise and reduce overtrading.

You are no longer asking, “Where is my stop?” You are asking, “What type of payoff distribution am I trying to build?”

What works best in this market phase?

Risk management should prepare you for the next phase, not just protect you from the current bar.

• If breakouts are choppy and follow-through is weak, should I use a 3-stop framework?

• If the market is trending cleanly and rewarding initiative, should I optimize for 10R+ outliers?

• If volatility is expanding, should I widen structure and reduce size?

Before we go deeper lets continue with a side by side comparison of both the methods and look at the practical edge they give.

Stop Loss position:

1. Jeff: Irrespective of the ADR, he places his stop position structurally at LOD which should not be more than than 60% of ATR distance. For High ADR stocks its usually around 3.5 % and for low ADR stocks its around 2% from historical data but could range around (2.5% to 6% on voltalitiy)

2. Martin: He does not use ATR but uses prev candle high/low, low of the day or key level. He tries to reduce this significantly by having them under 3% for high ADR stocks and less than 1% for low ADR stocks. (But could range from 1.5% - 5%)

   

Position Sizing & Portfolio Management:

This is where Martin’s aggressive trading methodology comes more into picture, he risks around .5% of his entire portfolio compared with around .2% - .25% but Martin could be using 35% of his entire portfolio to enter the trade.

When you create such a tight stop loss, as from the above math formula the position size increases significantly which means he needs more capital to enter while still maintaining max loss at .5% of his portfolio. The risk

Think of these models the same way you think about breadth regimes. One is more defensive and structural. The other is more offensive and precision-based.

Testing their methdology on breakouts:

While our goal with this tutorial was not only to shine light on two different risk management methods, we wanted to highlight one more key aspect of which method could be working the best during which market cycle. We took 300 breakout trades randomly sampled from a 1800 breakouts(Mix of A+,A setups) since May 2020 and ran the experiment 5 times.

Reward by Market Regime

Tight-stop methods tend to separate most in clean, trending or bottoming environments.

Drawdown by Market Regime

The smoother profile of the 3-stop framework shows up most clearly in mixed, ranging, and adverse regimes.

You can see with this experiment this method is extremely rewarding but it also comes with the pressure of being in drawdowns at -20% (as tweeted by Martin also) and this is where the experience, skills and discipline comes into play to not blow it away. We believe this is for traders who have changed their mindset, are extremely precise and extremely disciplined as one small mistake (slippage) and you are hit with heavy losses.

Final Takeaway

Think of risk management the same way you think about market breadth: as a situational awareness system.

When the market is broad, healthy, and rewarding clean momentum, it may make sense to tighten up and maximize convexity. When the market is messy, selective, or hostile to initiative, wider structural management and scaled exits may preserve both capital and confidence.

The edge with risk management is not just in setting the stop loss, max risk. The edge is in knowing which stop philosophy belongs to which market/setup environment and which comes down to skills and expertise