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Old 01-18-2008, 04:06 PM   #1 (permalink)
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Trailing Stops


In yesterday’s lesson we talked about some of the psychological difficulties people have with letting their profits run and introduced the concept of the trailing stop as one way traders can overcome these difficulties that are the downfall of so many traders.

As we spoke about briefly in yesterday’s lesson, once a position has begun to move in a traders favor many successful trader’s will manage that position through the use of what is known as a trailing stop. The simplest type of trailing stop is what is known as a fixed trailing stop which simply moves along behind a position as that position begins to move in the traders favor. The beauty of the fixed trailing stop, is that while it will move up behind a long position or down behind a short position as the position moves in the traders favor, if at any time the position begins to move against the trader, the stop does not move, essentially locking in a large portion of the gains the trader has made up to that point.

Let’s say for example that you had been following the trend in the EUR/USD chart below which started back in August and were looking for an opportunity to get into a trade. Based on your analysis you decided that if the market broke out above the little resistance point that I have highlighted on the chart below and the Average Directional Index (ADX) was in a good position that you were going to enter long at 1.4360 to try and ride the trend. To manage the trade if it moved in your favor you placed a 100 Point trailing stop on the position at 1.4260. Now in this example if the market moved against you from the start 100 points your stop at 1.4260 would not have moved and you would have been executed on that order when the market touched 1.4260. As you can see from the chart below however, in this example the market did not pull back but went higher. As our stop is a 100 point trailing stop once the market moved up from 1.4360 the stop is going to continue to move up remaining 100 points behind the current price. If the market moves down however the stop does not move. So in this example once the market stoped moving higher at 1.4752 so did our stop and since the market pulled back 100 points from that level we were stopped out in this example at 1.4652.


Most trading platforms will allow you to set a fixed trailing stop on the platform so you do not have to manually manage the order.

As we have touched on briefly in previous lessons, indicators can also be used as trailing stops. One of the more popular indicators which was designed specifically for this purpose is the Parabolic SAR which we covered several lessons ago and you should review if you have not done so already.

As we discussed in our lesson on the Average True Range (ATR), this and other methods for measuring volatility in the market are often used to set hard stops by traders when entering the market so they do not get stopped out by market noise. In addition to using the ATR as a hard stop, this and other volatility based indicators can also be used as a trailing stop, moving your hard stop along behind the position a set number of ATR’s for instance as it moves in your favor. As with a hard stop this protects your position from market noise, while allowing you to look in profits should the market begin to move against you.

Many if not all of the other indicators could also be used as trailing stops with the Moving Average probably one of the more popular here as well.

Aside from fixed and indicator based trailing stops another strategy that many traders implement is a fixed percentage of profits trailing stop. Using this method a trader will set his hard stop his profit target, and then once the market hits his profit target will then begin trailing a stop which could be any combination of the methods above. This method gives the trader a greater chance that the trade will hit his profit target but provides less protection should the market reverse and begin to move against him.

Links to Help You Learn About Trailing Stops

Trailing-Stop Techniques
How to Use Trailing Stops
Trailing Stops - Using Trailing Stops to Protect Profits
Interbank FX - Trailing Stops

That’s our lesson for today. In tomorrow’s lesson we are going to look at another aspect of money management strategies, position sizing, so we hope to see you in that lesson. As always if you have any questions or comments please feel free to 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 10-04-2008, 05:33 PM   #2 (permalink)
 
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Hello David:

Many thanks for your guidance and great work!

I was wondering if stop losses are effective in a current market set up where it gaps up or down several points the next day on open. How can one protect against this? Will you please advise.

Thanks
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Old 10-05-2008, 11:13 AM   #3 (permalink)
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Hi Maajoba,

Glad to hear from you.

If you have a stop in place and the market opens at a price the next day which is past your stop price then you will receive the open price. So in this sense no stops are not affective at getting you out of the market at the price you specify.

This is why many traders prefer to close positions out before then end of trading so they are not exposed to the overnight risk in the market. This is also why the type of market conditions we have been experiencing recently are what many people refer to as a day traders market.

Best Regards,
Dave
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Old 02-10-2009, 12:44 PM   #4 (permalink)
 
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Hey Dave as always thanks for all your hardwork.
Question..I hope this is the right place for it..I believe it falls under trailing stops.

I'll be using (FXCM) as my platform:
Lets say I feel the EUR/USD is in a nice uptrend, So I decide to jump in and BUY at 1.4360 amount 20k...I figure I'll walk away from my computer for a few hours, but before doing so I want to have a STOP in place at 1.4375 but only a 10K amount, so 1/2 of the start up...and let the other 10k ride forward...then close out the remaining 10k at 1.4390.

I'd do this in order to nibble at a little profit along the way PLUS save myself the entire loot..if it should turn around on me and go in a DownTrend...then ALL is not lost.

I hope that make sense
Thanks, TP
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Old 02-10-2009, 03:27 PM   #5 (permalink)
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Hey TP,

Glad to hear from you and don't worry about posting something in the wrong place its easy for me to move things around if necessary.

On the FXCM trading station whenever you refer to an order that is placed to take you out of a position when the market moves in your favor this is going to be what they refer to as a limit order.

Conversely, whenever you refer to an order that is going to take you out of a position if the market moves against you, this is what they refer to as a stop.

So the order type that you would be referring to in your question would be a limit order. The answer to this one is a little tricky however as the FXCM platform does not allow you to place a limit or stop order which is tied to an open position for an amount that is different than the amount of the open position.

You can however do the same thing that you are looking to do through the use of an entry order. What you would do is place an entry order to sell 10K at your specified rate, which will offset half of your open position if the market reaches that level.

If you want to do this however, when you open your live account, you need to request to have the "hedging" feature turned off on your account. If you leave things default then instead of closing out your open position, the entry order will initiate a new position in the opposing direction. I personally wish that FXCM did not have that feature on their platform but it is requested by a lot of traders who don't seem to understand that opening a trade in the opposite direction in the spot market is not a hedge.

Let me know if that does not make sense or if you have any other questions.

Best Regards,
Dave
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Old 02-10-2009, 05:12 PM   #6 (permalink)
 
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Perfect!! You explained it just the way i needed to hear it. I'll try it out on my Demo account
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Old 02-11-2009, 12:19 PM   #7 (permalink)
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Hey TP,

My pleasure. Keep in mind though that the default setting for demo and live accounts is to have hedging enabled so if you do this on a demo account, instead of closing a portion of your existing position, it is going to open a new position in the opposing direction.

I don't think that FXCM will allow changing of the hedging feature on the demo, but when you open your live account you can request to have hedging turned off, which will allow you to close trades as I have outlined in my above post.

Hope that helps.

Best Regards,
Dave
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Old 11-12-2011, 07:37 PM   #8 (permalink)
 
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Hey Dave Awesome Work,

I like how you use trailing stops i always waited for the market to retrace and form a low turning point, then placing a rising support line.

if you place a stop at for example say 100pts and the market moves against you 20pts then moving in your favour again would you place your stop 80pts below the next move or would you adjust it to 100pts again

Cheers
Dallas..
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Old 02-15-2012, 02:27 PM   #9 (permalink)
 
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Hi,

i like all of your explains but that's no news i guess. In this example you put an enter point at a moment where ADX has a bearish divergence and even crosses down. What's the sense of that?

In addtion I do believe that there is a H&S pattern on the top (nov-mid dec) but the trend doesn't change. What would you say how reliable H&S is? 50:50 ?
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