When It's Time to Move a Stop Loss to Break Even

One of the most common and expensive mistakes made by traders is moving the stop loss on a trade to break even too quickly. It is psychologically attractive to move a stop loss to break even in order to enjoy the feeling of removing risk, but it is usually not a smart thing to do as it tends to result in being kicked out of potentially profitable trade too early. Stop losses should only be moved either after a defined period of time has elapsed, or after the trade has moved in the trader’s favor by a relatively large amount, compared to the risk of the trade. Other methods of judgement tend to produce poor results.

The question of whether you should move a stop, and if so, when you should move it, depends also upon your style of trading, i.e. your tolerance for losses and your profit targets.

Should You Move a Stop Loss to Break Even at All?

There is a good argument for never moving a stop loss to break even. After all, if you test the profitability of a good trading strategy with clearly defined rules, moving stops will rarely make a great deal of difference to the overall profitability. If you treat the question of when to move a stop as art rather than science, you need to be a very good trader to get good results with it. Most new traders are probably better off avoiding moving stops at all, except for example where a trade is, say, already three-quarters of the way to its profit target.

If you have entered a trade and it has moved in your favor, all is going well. Remember that when you move your stop loss to break even, you are potentially limiting the upside as well as limiting risk. In fact, moving a stop is, in a very real sense, statistically the same as taking a profit. Why take profit early if you have faith in your trade entry? All you are doing is inviting the regular and normal volatility of the market to remove you from your position, and if you don’t have a position, how are you going to make any money?

The Statistical Reality of Trade Entries

If you look at all your trade entries, or a lot of entries generated by a strategy, you will find that in most cases, the price comes back to the entry level, even after a relatively considerable period of time has elapsed. Even when a technical development has occurred that indicates that the price is not going to come back there, for example carving out a higher swing low or lower swing high, it is still likely to return and hit your newly breaking-even stop loss.

To give an example, I examined a trend trading strategy that has recently produced excellent results. The stop loss is one day’s average range, so it is adjusted for volatility. I looked at all the really good entries: the ones that produced winning reward to risk ratios of at least 5 to 1. The result was that it was only safe in about half of these cases to move the stop loss to break even once 48 hours had elapsed. Of course, this was a longer-term trading strategy. However it goes to show you that while it may be true that many of the very best trades go into profit right away, this is not usually statistically common enough to build a winning strategy upon.

Common Approaches to Adjusting Stop Losses

Defined Time Period

One approach that can work is to wait for a defined length of time, one that should have given your trade enough time realistically to “breathe”. Once this time has elapsed, if your trade is showing a loss, exit immediately; if a profit, move the stop loss to break even. If you apply this method consistently, you could save in early exits from bad trades what you miss in any early exits from trades that turn out to be good trades after all.

Floating Profit Equals Certain Amount

You could apply the maxim “don’t let a winner turn into a loser” by moving the stop to break even once it has performed well enough to be out of the “orbit” of the entry level. You will probably be best served by waiting for the trade to be in profit by at least 3 times the amount of the stop loss before doing this.

Trailing Stop Loss

This can work, but should also not be applied until the trade is in profit by at least 3 times the stop loss, and the size of the trail should be based upon volatility.

Technical Stop Loss Adjustment

A very common approach, which usually involves waiting for any of the following to occur:

1. A failed retest of the entry point
2. A significant higher high or lower low that “confirms” the entry
3. A successful breakout in the direction of the trade
4. A failed breakout against the direction of the trade

These can work sometimes, but will not usually work often enough, especially in intraday trading.

Fixed Pip Amount of Profit

Here the stop loss is moved to break even after some fixed amount of floating profit has been achieved. This is a bad idea except where the price is much closer to the take profit point than the entry point.

Conclusion

Moving a stop loss to break even is the same as taking profit. If it is too early to take profit, there is no point in moving a stop loss to break even. Except in cases of very skilled traders, it is hard to be profitable if you are aiming for an average reward to risk ratio less than 3 to 1, so it is probably a bad idea to be moving stop losses to break even any sooner than that.

Every currency pair or cross has an average daily range of volatility. If your stop loss level is within half of that amount, it will probably be hit within the next day or two. Consider whether that gives it enough time to reach the kind of profit target you are looking for.

Do not be in a hurry to adjust a stop loss.

Source: http://www.dailyforex.com/

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Ways to Achieve Trading Perfection

Achieving Trading Perfection - Trade quality, not quantity. Take the best of the best. Get the big picture. If you haven't previously come across such advice, or if you have and are not following it, it is time that you take these words to heart. But how?

Trade selection and adequate planning go hand in hand. This is where most would-be professional traders miss the boat. Much more money is made as a result of proper planning than from sitting and trading everything that comes along or "looks" good. It's difficult to fully understand why people think they have to trade so much. It's difficult to truly grasp why people think that they have to take as many trades as they do. Just the opposite is true. There is a correct approach to each and every trade. That is what achieving perfection is all about.

It all starts with proper management: planning, organizing, delegating, directing, and controlling. These facets of management must be woven together into your trading; they do overlap. Although planning is the major management function involved in achieving perfection, you can't possibly plan well unless you are organized to do so. You must have your tools at hand: your trading software, your data, the proper equipment. All of the rudiments for planning must be in place, which in itself is a part of organizing.

You must be physically fit when you plan: well nourished, properly exercised, well rested and mentally alert - all part of having your life organized, all part of achieving perfection as a trader. To be a winning trader, you have to be among the best. There can be no middle ground. There are only winners and losers, and to be a winner you have to be a champion. And, just like any champion, you must have discipline, self-control, and a willingness to train, train, train.

There are no runners-up in trading, you either get the gold or you give the gold. Often, while others are busy going to parties or watching sports events, you are busy poring over charts, studying, thinking, planning. When others are listening to music or watching TV, you are busy practicing your trading, practicing trade selection, working hard to become a more astute trader.

Part of achieving perfection involves the diligent study of charts. The data, as presented on your screen and preserved as charts, are, for the most part, all you have for making trading decisions. They are a picture, a visualization of what is taking place in the reality of the market. Your job in achieving perfection and becoming an adequate trader is to picture and imagine in your mind what makes prices move and form the way they do. Ask yourself, "How does what I see in front of me relate to the supply and demand for the underlying?" Ask yourself, "Is what I am seeing on the chart even related to supply and demand, or is what I am seeing related to an engineered move by some insider or market mover?"

Supply and demand are not what makes prices move or fail to move most of the time. The sooner you realize that fact, the better off you will be. Markets are engineered, manipulated ¾ you need to know that. But there's more to a chart than merely price patterns. Reflected in the chart are the emotional reactions of human beings. Reactions to rumors and news; to national and world events; to government reports - these, too, are on the charts. You might say that price movement, or the lack thereof, is the net effect of all the perceptions of all the traders who are participating in the market for a particular futures.

There is something else on the charts, something that too few take into account. That something is the manipulations from and by the insiders, the market movers, and by commercials holding large inventories of the underlying you are attempting to trade. In achieving perfection as a trader, you must train yourself to look for evidence of any and all of these things as you study your charts. It is the cumulative action of all perceptions which causes patterns to form on a price chart.

You must learn to look for the truths in the markets. There are certain truths which are self-evident; they are always true. For instance, take the phenomenon of a breakout. When prices break out, no one can change the fact that they did break out. It is a fact and it is true. The breakout may turn out to be a "false" breakout, but nevertheless it is a breakout. As part of achieving perfection in your trade selection skills, you have to learn to tell which breakouts are most likely true breakouts, and which ones are most likely false. How can you know? By the price patterns on the chart.

And what about trend? Your job in achieving perfection as a trader is to master how to trade a trend. A trend is a trend, is a trend. It is a trend until the end, and part of your job is to know when a market is not trending.

The trend is the trend while it lasts. While a market is trending it is telling the truth. The trend can change, but the truth is the truth. If prices are rising, the trend is up. If prices are falling, the trend is down. The truth can be found in the trend. It is an immutable fact.

You are to learn to make my money by trading with the trend. You are to learn what constitutes a trend. You have to learn to spot trends early so that you can make the most out of the market while it is trending. Your job in achieving perfection as a trader is to learn to recognize when a trend will most likely begin, and just as important, to learn to be even more adept at deciphering when a trend is ending.

In achieving perfection, you must learn to recognize "your" trade(s), and to take only "your" trades. Trade the formations and patterns that you can easily recognize and identify.

You must learn to trade using tips and tricks that you are shown and to accumulate and keep a collection of techniques that result in the selection of high probability trades.

How are you to do all this? Practice, practice, PRACTICE. Practice recognition of congestion areas. Practice recognition of high probability breakouts. Practice trend recognition. Practice and more practice. Just like anyone who wants to achieve perfection at anything, there must be total dedication, study, practice and more practice. You are to become a trading virtuoso. You are to practice, yet always realizing that you will never attain true perfection, that there is always room for improvement. There is usually a way to refine: ways that you can do things better, more efficiently, and with greater speed and finesse.

Source: http://tradejuice.com/

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How Investors Can Win in a Volatile Market

Increased volatility leads many traders to seeing an increase in trading opportunities. The huge market swings trigger thoughts of monumental upside, but also for potential loss especially if traders do not take the necessary precautions. During times of volatility, traders need to adjust their strategy to compensate for erratic market. When trading during these market conditions, traders should follow the rules below.

1. Be More Selective Before Placing Trades

Wanting to take advantage of all the trading opportunities that present themselves in volatile markets, traders are tempted to place an increase number of trades. This temptation should be avoided. It is important to remember that in volatile times, losses are likely to be big. Before placing a trading, assess risk tolerance levels. Determine the level of risk that is acceptable for the trader both psychologically and financially before placing any trades.

2. Use Less Leverage

During high market volatility, losses can be traumatic. With the average trading range increased in volatile times traders should be considering how leverage will affect trades. At a one percent or even a half percent margin, investors should be mindful of how much leverage or even the size position being traded can affect their portfolio. In normal market conditions, placing a 2 lot position is fine when you are looking to make about 50-100 pips. During a more volatile time, when the potential loss is 100-200 pips, it stops being an effective risk to reward ratio. To compensate traders should look to taking on smaller trading positions, in this case only one lot as opposed to the average 2 lot position.

3. Trade with More Discipline

Traders should always follow their predetermined trading strategy regardless of market condition. During volatile markets, this is even more important to use that same level of restraint. Traders must adhere to any set stops, contingency plans or risk management benchmarks without hesitation. This will help to define how much risk is taken should price action be uncontrollable. Without this level of discipline and self control losses can be great.

4. Tighten Stops

Many traders are hesitant to use tighter stops in volatile markets because they see the large swings increasing the likelihood that the position will be taken out. Having tighter stops can also provide great risk managers in times of extreme volatility. For example, on a EURUSD trade, rather than setting an 80 pip stop to protect your position, consider placing a 50-60 pip stop. This will insure the protection of your currency position and if the stop is broken, there is a high likelihood that the trend will continue lower and the stop took you out before you could potentially lose more money.

The width of the stop being set does depend on the currency pair being trading as some pairs have wider ranges. In a Yen cross like the GBPJPY or AUDJPY, traders may be more likely to have wider stops as their average daily range is 50% more than that of the EUR/USD. With that said, stops during volatile market conditions should not as wide as before. Instead of a stop 100 pips below entry, traders may consider a 25 pip reduction and have a 75 pip stop. Below is a chart showing the EURUSD and the GBPJPY on the same very volatile day in the forex market. The EURUSD had an impressive range of nearly 600 pips! The GBPJPY far dominated though with nearly a 2000 pip trading range.

5. Be Prepared

It also helps a trader to know what is causing the current spate of volatility in the markets in order to be prepared for the unexpected. As such, an investor can accommodate their strategy to the market environment and not just the currency pair being traded. The first of these considerations is accounting for emotions in a market: is fear currently driving the market lower? Or is it buyer's mania that is keeping the bullish tone alive? Traders' overreaction and emotion tend to push markets to overextended targets. This fact alone creates volatility through simple supply and demand.

Volatility can also, and more than likely will, be sparked by economic events. In this instance, market participants may interpret fundamental data differently and not as cut and dry as the more novice trader. A perfect example of this is usually monthly manufacturing reports that are released in pretty much all industrial economies. The classic scenario has the market honed in on a particular number for the month. However, traders young and old will sometimes wonder why the market sold off if manufacturing showed positive growth. The answer is simple. The market had a different interpretation and positions were violently reshaped and shifted. These tend to create great opportunities for some and horrible memories for others. Below is an hourly chart of the EUR/USD during ISM Manufacturing for October 1, 2008. Here we can see the huge price gap that occurred due to market volatility as well as the resulting trend.

Panic and erratic momentum can additionally be found in certain market environments. Not to be confused with fear or greed, panic selling and buying can create very choppy and relatively untradeable markets. These conditions will lead some to flip flop their positions while leaving others gaping at the fact that the position was right, only to be stopped out prematurely. These two common examples will create further panic and volatility as traders abandon their own individual strategy for the possibility of instant profits or stoppage revenge. As a result, a vicious cycle of volatility ensues until a definitive market direction can be established.

The simple rules above, and a task of getting to know the current trading environment, can empower every trader through the ranks. Although some relate volatility with difficult and untouchable markets, opportunities continue to remain abound in these less than attractive conditions to those focused and fortunate.

By following these five simple steps, trading in volatile market conditions should be a little simpler. Don't forget to adjust leverage based on volatility, follow your trading plan, tighten your stops and know why you are getting into a trade before you place it.

Source: http://www.actionforex.com/

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