Thursday, November 10, 2011


I never know as I do posts each day here who is reading or what exactly the levels of experience are. I think in general it is likely I have more beginning level types of readers. I am going to go over a few things today that might be rudimentary, but they have come up in questions over the last couple of days.

Stop Placement


For the most part I enter trades above or below prior days highs or lows. The only real exception is when I am trying to limit my way into something after it has already traded through my entry price. I would do this either because the initial stop was too big, or because I am trying to add on to something I am already in.

I have studied entry patterns for bars til the cows come home, and for the life of me I have never found anything that really has a significant edge. Many are 45 to 55% accurate, so essentially not much better than a flip of the coin. I guess for me why I enter above highs and below lows is that it gives me tangible stop loss points which enables me to dial in my risk precisely. Controlling risk is my number one priority far beyond anything else. I know as long as I only lose 2% or less when I am wrong, that I really have to have a streak far worse than anything I have ever experienced to get blown out.

I have studied inside bars, outside bars, small range bars overall, volatility breakouts. they are all the same. There is no definitive edge in any of these and don't let anyone tell you otherwise. In the case of the Aussie dollar entry I showed yesterday, it was below the low of the inside bar from the prior day. I knew I could stop it on the other side of that bar and have a tight risk parameter. It also was going to be breaking below a flat ledge in price if you look at that chart, which often leads to larger moves. None of these things are absolutes. It is simply a way of quantifying risk tying it into what I felt was a bearish overall setup for currencies and bullish the DX. 

You can also use basic trend lines and come up with your own rules as to how to qualify them. I have no magic here but I think that is valid. The reason I think that is at times they have obvious price containment points and when we break free of them we are off to the races. Some of my best trades come from this basic type of entry.

I am not doing a complete dissertation on this here, that would be for a book someday. The point here is that when I show entries, this is generally how I am getting into them.


Here is another topic that there is no magic to. I would say that in general when I enter on one side of a bars range, the stop is usually on the other side of that range initially. As a trade moves in my favor I like to have targets and trailing stops. I like to keep the trailing stops above or below pivot points or on the other side of large ranges. The basic thinking there is that I know I am wrong if those spots are taken out. Beginning traders, and I did this also at the beginning, keep the stops way too close because they are too afraid of losing money. The harsh reality is that if you have $10,000 or less you probably should not be trading and should wait until you get 15 or 20k. It is not impossible, but the odds are strongly against you if you have too small of an amount. It is just not enough to allow you to do the right things. If you arbitrarily impose your own limitations of risk on markets that are billions of dollars, you cannot expect to have them honored. The markets don't care if we are afraid of losing and as a result have our stops in the wrong place.

The lion share of price action is random, so you have to realize that and not put stops just in the middle of nowhere, they will get picked off over and over again. To me I would rather lose a few grand giving something the chance to make me a lot more than that, than get picked off on a break even stop and feel good that I was saved. Are you trying to make money or trying not to lose. If you are trying not to lose you need to change your game plan. You will lose whether or not you want to, so why not also give yourself a chance at big wins?

This chart above shows all of the concepts I talked about today.  This is a trade I made recently that I told people about in advance, and this is exactly how I traded it. I had just a basic trend line down that came in right above the small range bar. I liked that because it allowed a lot of contracts just buying above the high of that bar and stopping it below the low of that bar. You could argue that the stop was too close, but I do not agree. This is all about just probing to catch moves. If I had been stopped out who cares? It is just one trade. I think I made close to 50k on this trade adding all my accounts together that I took this trade in, so that shows how powerful trailing stops and giving the markets room can be.

As the market took off we had several large range bars and I just moved the stop up underneath those bars until it hit my target where I had a limit order resting to exit. Obviously not all trades work out like this. Often when you get these big bars you consolidate within them for a day or two, then take off again. In this case had you had some arbitrary intra bar stop I doubt you would have been picked off, so you would have gotten away with doing the wrong thing. However, if you just look at charts you will not see that many moves that don't have at least a few wiggles in them. You could have just continued to trail the stop up in this trade and made quite a bit more than I did once you got picked off.

That is how I do it for better or worse. As to the overall market, we are at an interesting juncture here. We are just under the 200 day moving average here so it is still possible we could turn back down here. Yesterday's event driven decline is just another one of these events that reflect overall how the world economy is really doing. It remains to be seen if the attempt by the worlds governments to keep the bubble inflated will work. Bigger picture I don't think it will, but in the near term I think they will be able to artificially hold things up for a while.

This is a very difficult trading environment so do not be too hard on yourself if you are having trouble with it. It is a tug of war between harsh economic reality, and governments trying to manipulate that reality. I read something yesterday that said "the Italian Bond market can't be allowed to trade this way." I did not realize it was up to someone to decide what to allow markets to do and what not to do.

It is a zany world we live in right now.

Good Trading

1 comment:

John M said...

Nice post, Chris. Good refresher even if somebody's not still a beginner.