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Old 01-14-2008, 03:44 PM   #1 (permalink)
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How to Up Your Chances For Profits When Setting Stops



In our last lesson we learned about the Average True Range (ATR) and how traders use this to get an idea of the volatility in the market so they can incorporate this into their stop levels. In today’s lesson we are going to add an additional factor that most traders consider important when setting stops, support and resistance.

As we have learned in previous lessons many traders will use technical analysis to determine where support and resistance is in the market, and look for trading opportunities based on what that chart analysis tells them. In addition to using technical analysis to find support and resistance levels in which trades can be entered, many successful traders also use this method of analysis to determine where their stops should be placed.

One of the most popular methods which we have touched on in previous lessons where many traders use support and resistance in their stock, futures and forex trading strategies is when trading ranges in the market. Many traders favor ranges, as they provide traders with the ability to enter trades with tight stop losses and much larger potential returns. The reasoning here is that traders can enter a trade just below resistance or just above support in the range, place their stop just outside that level and then their profit target at the other end of the range. Generally the distance between the stop level is much shorter than the distance between the other end of the range, providing traders with a great opportunity for a relatively low risk and potentially high reward trade.


This is also another example of using tech levels (the bottom and top of the range) to place trades and set stops. Often times however as many traders are employing this type of trading strategy, the market will jump up or down above/below the resistance/support level stopping traders out of trades before quickly reversing and moving in the favor of the traders original entry price. Because of this traders are faced with the dilemma of how far to place there stop outside of the range that they are trading, so that they can be in a position where they are protected but are less likely to be stopped out on market spikes. One way that this can be done is by incorporating the ATR.


Although the example above shows 1 ATR. as the level at which the stop is placed outside of the range. That number could be a percentage such as 50% of the ATR. or any other multiple of the ATR such as 2 ATR’s outside the range, depending on the traders time frame, profit target, and strategy.

To finish off this example we now have several components which make up a basic strategies for placing stops based on technical levels and can now analyze the feasibility of one of the trades here to see if it fits all of our criteria.


So in this instance with $10,000 in trading capital and our 115 point stop we are not only well within the recommended 2% loss limit, but we also seem to have a healthy profit ratio on the trade.

That’s our lesson for today. In tomorrow's lesson we are going to look at another method of placing stops with a look at placing stops with chart patterns so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

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Old 05-21-2008, 03:43 PM   #2 (permalink)
 
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ATR


Hello David,
Was reviewing you ATR video...as always, thanks for all you do...Your ATR video sort of sparked a question re. useing ATR to set trailing stop level....What do you think about and entry technique, that would place the initial trailing stop at 1 1/2 times the ATR...and then as the price movement moves on towards resistance, then changing the trailing stop so it trails closer to the price in order to protect profit, and not lose profit due to a normal market retrace..??? Perhaps Im being more theoretical than realistic...I dont know...can you comment pls....Thanks Jerry
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Old 05-21-2008, 05:31 PM   #3 (permalink)
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Quote:
Originally Posted by Jerry View Post
Hello David,
Was reviewing you ATR video...as always, thanks for all you do...Your ATR video sort of sparked a question re. useing ATR to set trailing stop level....What do you think about and entry technique, that would place the initial trailing stop at 1 1/2 times the ATR...and then as the price movement moves on towards resistance, then changing the trailing stop so it trails closer to the price in order to protect profit, and not lose profit due to a normal market retrace..??? Perhaps Im being more theoretical than realistic...I dont know...can you comment pls....Thanks Jerry
Hi Jerry,

As far as how many ATR's to place the stop away I think that would depend on the strategy but as far as using the ATR as a factor in placing the initial stop and the trailing stop I think most would consider a good idea to try out.

How I think many traders use the ATR is in combination with other things like you mentioned in your above comment "when it approches resistance" tighten it up using the ATR so I think that line of thinking would be worth exploring.

Best Regards,
Dave
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Old 08-07-2008, 08:53 AM   #4 (permalink)
 
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Hi Dave,

Thanks for your reply to my other questions.

I was just reviewing this lesson after noticing something that I changed in my trading that really helped my results. Basically to start with I was placing my stops too tight to minimise the money I could lose.

When I loosened them up (making sure my profit:loss still made sense) not only was I avoiding being stopped out, I suppose I was also benefitting from all the other people who were acting as I had previously and were getting stopped out. Please confirm if I am understanding this correctly - when positions are stopped out en masse there is a sudden buying or selling in the market. If I am looking to go long on a trade and the value spikes down before continuing up, this creates a further sell-off as stops are hit and an opportunity to buy at a lower price.

I'm just guessing here but because the major movers in the market are not individual traders, then this spike created by the sell off from stops being hit will probably be low volume and so won't create momentum in the overall direction of the market. It will however mean I can get a better price, still go long with a good chance of success and basically make money from the mistakes of other traders.

I am new to this so I have probably got things twisted but if you could confirm or correct my understanding that would be great.

many thanks

dave t
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Old 08-07-2008, 09:23 AM   #5 (permalink)
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Hey Dave T,

I would say that's a pretty accurate description of what happens and the fact that you came up with that on your own early in the game I would also say says that you are way ahead of most people when they were at your stage of the game.

Best Regards,
Dave
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Old 08-11-2008, 05:21 PM   #6 (permalink)
 
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I appreciate the words of encouragement Dave but obviously I wouldn't be working things out at all without the help of this website, so thanks to you.

I wanted to pose a few more questions related to stops and profit targets if I may.

In an ideal world I would have a strategy whereby I can analyse charts for an hour or two, place a number of trades when the right signals are on, then walk away and "forget" about them feeling fairly confident that I will get a 40-50% success rate. Sounds too good to be true I know.

Partly this would be so I could use my time for other things and partly so that I would be shielded from emotional decisions which could ruin my profits when it comes to trading real money. So far I have found this to be my biggest downfall.

Do you think it is realistic to ever be able to do this or should I concentrate on following my trades? I am currently testing by letting all my demo trades run their course and blindly trusting my initial analysis once I am in the trade. It is very hard not to pull out if I see the trade not going my way and to limit my losses as much as I can, but this is something I would have to be able to do in order to reach my goal. I mean, the stop loss should be strategically placed to allow the leeway for a successful outcome anyway, at the same time as automatically limiting your losses, right? Or....does the stop loss become irrelevant and meaningless after a certain point? It sounds weird but I try to embrace my wins AND losses as a vital part of a winning strategy and get some satisfaction out of the fact that they are under control. Maybe I'm nuts and should be cutting my losses as soon as I see the trade going against me.

Also, do I trust my profit targets in the same way? My current thinking is that if I place them comfortably before where the estimated target is, I can trust they will usually be hit if the trade goes my way. Without a fairly large degree of trust it seems like the risk/reward calculation made before a trade seems almost meaningless.

Sorry for the waffle and multitude of questions! I tend to get carried away which is one of the reasons I want as emotionless a trading system as possible.

thanks in anticipation of any thoughts you or anyone else has on this.

Dave T
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Old 08-11-2008, 08:00 PM   #7 (permalink)
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Hey Dave,

Thanks again for the compliments I am glad you like the site and are finding it useful. Below are my thoughts on your questions:

Quote:
In an ideal world I would have a strategy whereby I can analyse charts for an hour or two, place a number of trades when the right signals are on, then walk away and "forget" about them feeling fairly confident that I will get a 40-50% success rate. Sounds too good to be true I know.

Partly this would be so I could use my time for other things and partly so that I would be shielded from emotional decisions which could ruin my profits when it comes to trading real money. So far I have found this to be my biggest downfall.

Do you think it is realistic to ever be able to do this or should I concentrate on following my trades?
One of the most important and often overlooked things that a trader can do in my opinion is build a strategy which fits into their personality so I like the direction you are going here.

I believe that it is absolutely possible to spend 1 to 2 hours a day analyzing the market and putting your trades on and then walking away. The key here in my opinion is developing a strategy that incorporates the fact that you will only be analyzing the market for an hour or two a day and you will not be sitting in front of your computer watching the trades as they happen.

In my opinion you will probably want to steer clear of day trading as a result of this and try and work out a strategy which is more swing to long term.

Quote:
I mean, the stop loss should be strategically placed to allow the leeway for a successful outcome anyway, at the same time as automatically limiting your losses, right? Or....does the stop loss become irrelevant and meaningless after a certain point? It sounds weird but I try to embrace my wins AND losses as a vital part of a winning strategy and get some satisfaction out of the fact that they are under control. Maybe I'm nuts and should be cutting my losses as soon as I see the trade going against me.
I definitely agree that a successful trader needs to learn to embrace both their wins and their losses but I am not sure if I am understanding what you mean by does the stop loss become meaningless after a certain point.

In my opinion it is trading suicide to trade without a stop loss or at least a pre determined point where you will manually close the trade if you do not enter the actual order.

When you ask if you should be cutting your losses as soon as the trade begins to go against you in my opinion that depends on what you mean by the trade going against you. The idea of a stoploss in my opinion is first to protect the account from losses that violate your money management strategy. Second it is to allow your trade enough room to breath through normal market movement without taking you out of the trade before you hit your profit target.

Does this mean that you cannot close out the trade before the market hits your stop? In my opinion no, but when you do this it should be because something has changed about the initial reasons why you entered the trade that negates your initial analysis, not simply because the market started to move against you.

Quote:
Also, do I trust my profit targets in the same way? My current thinking is that if I place them comfortably before where the estimated target is, I can trust they will usually be hit if the trade goes my way. Without a fairly large degree of trust it seems like the risk/reward calculation made before a trade seems almost meaningless.
In my opinion yes the same answer that I gave above for the stop applies to the take profit order as well.

One thing I think you will find very benificial here is if you keep a trading journal. This will allow you to see if the times when you exit trades before your stop or take profit is hit is based on sound analysis or simple emotion.

As a general rule here as well, I would say the less experienced the trader the more important it is to stick to your original plan as emotion instead of a good feel for the market is more likely to be the driving force behind deviating from your plan when you are starting out.

Quote:
Sorry for the waffle and multitude of questions! I tend to get carried away which is one of the reasons I want as emotionless a trading system as possible.
No worries that is what the community is here for. If there are any other questions or comments please feel free to post as always.

Best Regards,
Dave
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Old 08-29-2008, 11:36 AM   #8 (permalink)
 
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Hi Dave,

I just wanted to update you on where I was at with some of the things we discussed above.

For a start, after what you said I have started practising more swing trades as opposed to day trades and have found the following main things:

1. Patterns do indeed seem much more more reliable on the longer timeframe charts.

2. The progress of the trades is a lot calmer simply because the movement usually takes longer, so I am less anxious to check progress every few minutes and feel I have time to consider my options thoroughly if things aren't going my way.

3. When calculating my position size and stops I have time to do it properly and not make stupid errors. On shorter timeframes I tend to rush so I don't miss the move I'm trying to get in on and lose my initial profit/loss ratio. In fact not missing the move becomes the all important thing and all rational thought and care flies out the window at this point.

4. The price I buy or sell at actually matches much more closely the position on the chart because the spread doesn't take such a large chunk of the profits. This means I can quickly visualise the actual profit ratios of possible trades on charts and not get a nasty surprise if I hit buy and see that the actual price I paid is already half way to my profit target.

I find shorter term trades more entertaining, fun, exciting, stressful etc. but so far less profitable for me.

I have been keeping a trading journal almost since I started and find it essential for working out what my strengths and weaknesses are. It also adds a bit of comfort and sobriety if something doesn't go my way - I grimace while I make the relevant notes of losses and reasons why etc. and then it feels like I've at least put that mistake down to experience and can move on.

So after hearing your feedback I think I am making better progress with developing a system that will work for me.

thanks,

dave_t
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Old 08-29-2008, 02:51 PM   #9 (permalink)
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Hey Dave T,

Glad to hear from you and thanks a lot for providing that feedback I am glad to see that you are progressing well.

I feel pretty much exactly the same way as you do about swing trading vs. daytrading which for everyone else out there I think it is important to stress doesn't make that strategy better than day or position trading, it just means that swing seems to fit our personality styles better.


Best of luck with everything and as you become more comfortable I would love to hear your thoughts on some of the markets that you are trading.

Best Regards,
Dave
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Old 01-20-2009, 05:13 AM   #10 (permalink)
 
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risk reward ratio


I do agree with this stop strategy, but one day i red about how to place a stop order while you are trading a head & shoulders, and there writes that if the formation is in a bull market, it's a continuation pattern, and when it's in a bear market the head&shoulders it's a continuation pattern as well, like flags pannents and ascending wedges.Now, about placing the stop, the author of the book wrotes that is better to place your stop above the HEAD, because he explains that the nature of funds manager and banks as well, they deliberate raise the price above the right shoulders in purpose to stop you and taking losses; and I don't understand why a risk reward ratio 1:3. I use a strategy to place a market order with stop and limit as well, but I use to place the stop at 3 ATRs away from the market price. So, if I multiply the pips in order to give my reward ratio as 1:3 or 3:1 don't matter. If I risk 3ATRs away, that means i must take profit on 9ATRs away in my favour. That being said, if I used to wait a month in an open position, whit this money management strategy, I should wait a month and a half in the hypothesis that the markets rally or falls in a month 600 pips, and 1ATR is 150 pips. Maybe is not the proper place to post this comment, but I hope you don't mind it.


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