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Creative stops

In this video Kym Watson looks at placing stops, how you might be more creative with placing initial stops and demonstrates how he trails his stops on open positions.

Hi this is kym Watson of Ezee Trader.

What I’m going to do in this review is a two part review. The technical analysis is in a separate ling, what I’m going to do here is look at creative use of stops.

Last week I covered the subject of “what can you learn from 43 million trades” and it was really looking at the analysis made from FXCM’s traders, people that have been trading with them and how they have won and lost money.

Principally, people got more winning trades than they lose but the problem is that they’re losing more on the losers than they are making on the winners. Part of that is because we don’t like losing, part of that is because we put our stops in the wrong places because we will allow a trade a much bigger stop than we will aim for in reward.

We may have been short from this point with the principle of having a stop up here, but we’ve allowed it to go even further and then when it’s got all the way back to where we went short we have come out with maybe just a couple of pips profit.

What we’re going to look at are a few principles behind placing stops in the first place regarding risk/reward. I use technical analysis to choose a stop, I don’t have a standard 10, 15, 20 pip stop. Quite often it is around that but it’s not exact science, I’ve got to look at where the technicals suggest I place them.

Let’s assume I’m looking for a short position, the question is where do I place my stops? Well the question is where is my target? I’ve got to be looking at both. So how much am I willing to lose and is that sufficient to allow the market to move before it gets to my winning point.

If you’re entering a short position and then put a really tight stop behind it you’re going to get stopped out all the time. I know traders who use five pip stops and I know Charlie uses crafty little aggressive stops in because the market is moving so much with you, however in a lot of cases if you only put tight stops on and the market is not moving with you, you’re going to be out of your trade before you know where it is.

You’ve got to have reasonable stops in the first place generally. The amount of stoppage should depend on the market you are trading and volatility. You should generally get an idea from the average true range. So you’re trading relatively to where you are.

If you’re placing stops that are significantly less than that average true range, the chances are you’re going to find yourself stopped out quite frequently.

Let’s just look at this example here because it’s got some logical places to put some stops. You could be looking up here, or even further. From a technical point of view that’s where traders could be placing their stop.

Target-wise, some traders will be looking for a bit of profit here and some will be looking for the end of that bar, which I think is quite risky. Some will be looking down here and of course there’s potential further down.

This is pure technical analysis, assuming there’s not a lot else and assuming there’s not a lot of support resistance or anything in the way, it’s just a clear market barring these technicals.

So if you’re using stops up here with targets down here, even if you’re right a lot of the time you’re going to predominantly lose money, so you’ve got to use methods that are logical. If we do get into a short position there are several ways of playing this.

The first way is to just place the stop above that area, sometimes price will charge up there but they shouldn’t as long as you’re not too close, if you’re five pips away then they probably will do. If you’re 10 or 15 pips away and on the right side of the market then they probably won’t do.

Even if they do go back up there and stop you out then there’s a good chance that the market might be changing direction anyway.

So you’re looking effectively at a lower high. I generally look at lower highs or higher lows as where to place stops on a target. In this particular case you’ve got a high here, broke down, come in, got a new high in and took that out. That’s a lower high.

If it came back down and it broke this low then you’re expecting a continuation because it’s in a downward trend in that timeframe.

So you’ve placed your stops here looking for that first target and you think it could work but your risk/reward factor just won’t be working. You could be hopeful and put a stop up there and make that a single target and just looking at it, it will probably work okay, there’s an opportunity and I’ll talk about that more in a moment.

You’ve got to have some balance in what you’re doing. I’m assuming the trend is largely down on the bigger timeframes, so you’re trading with the moves, you’re taking this counter trend move as an opportunity to go with the bigger trend.

You can split these targets, you don’t have to come out all in one go. By splitting the targets, as long as there’s enough risk/reward, if you can gets some more runners with some modest stops then your risk/reward profile will look quite good.

You’ve got to realise that if you do lose here at 15 pips at £3 a point then you’d lose £45 on that all in one go, whereas if this was only £20 well then your first chance there is only £20. So whilst you’ve taken first profit, if you leave the stop there, as you should do initially then you’ve taken a third of the risk off there so you’re down to £30 risk at that time.

So your dynamics change as you go through. You could move your stop to breakeven, these are the sort of thing that traders will do. Sometimes I do this, if I’m 20 pips down on a move in the morning then I’ll be a bit more aggressive and move the stop down. I’d rather wait for the price to break these lows, I’ll explain why in a moment.

There are other alternatives. If the market is a little bit more volatile and you’ve done your analysis and you’re pretty certain on how things will run here then you could have two stops. I talked about two or three exits, you could also have a bit of space for your stops.

So you could say, I’ll have my main stop there and a stop up here just to give it a bit more width, but you’ve got to bracket these. So this one has to run at least that much, I can’t start taking profit off this position too early. It’s probably 1:1 on the risk/reward there, it’s not the best of examples but that’s the principle.

Give the market some movement if it looks a little bit volatile. It’s a slightly different way of doing things. We can be a bit harshly aggressive with the stop. I’ve just mentioned about putting a stop here and here, you can take part of the stop down and leave part of the stop up there, so just give in a little bit of wiggle room for the second part.

You don’t have to start the trade in a different way, it may be that you start here with £45 risk at £3 a point, you’ve taken a pound off down here, you bring a stop down for part of the trade for £1 effectively and you leave the original one where it is.

It gives it a bit more flexibility to get the targets that you’re looking for. In a market where you’re looking for two or three targets we can get big movements that go either side a little bit and it may just take this one out if you’re too aggressive, but that’s fine if you’ve come out at breakeven, you’ve made zero on the last bit and £20 on the first then you’re only risking £15 on the third and all of a sudden your ratio has changed around a bit because you’ll make £5 if it takes your third part out.

It’s just a different way of thinking in terms of stops and the way you move them.

In terms of once in a trade, there are ways of managing trades for example, say I’d bought here, there’s a really good trend up here, it’s had a little retrace and it’s starting to move in the right directions. Original stop is down here. I’ve got a really good target up here with an 80% chance of getting hit.

When you’re sitting with that probability this looks good, there’s points of resistance on the way but overall the position looks good. Now there are areas that you’ll be looking at thinking you may want to take some profit off.

If you do it too soon, in this case, it’s not going to be too bad, in this case about 1:1. Instead of taking profit some of the time, you can just start moving your stop. Yes, we’d like to bank some profits and in the morning when the markets are uncertain there is some logic in banking profits sometimes, so you can’t have a hard and fast rule.

Looking at what’s happening when you’re trading, if you’ve got an 80% chance of this being hit, you could argue there’s reason not to do anything and just walk out, and they will be the most profitable people generally.

We sit here and we look at screens and the more you look at them there’s the temptation to do something, like if a moving average changes or price is taking a long time to do something, you have got to be a bit open.

But if you want to really be managing things as you come up, you’ve got your initial stop here and your entry here and potentially a first target up here, you may want to take a small part off. I’d potentially look to take a third of the trade off at this point here because it’s locking in a bit of profit.

There are various things I could do here, we could move the stop straight up or we could do what I suggested a moment ago and take a third off and I could at that stage move one third up there and leave one back here. So just in case it comes down and nicks me out here and still runs up then I’m still in the trade.

The next thing to do alternatively is move all of the stops up, so you’re at £2 a point just below the low because as it’s broken this high and put a higher low in it is safer to put your stop just below the lows. So you can move your stop to just below breakeven and wait for it to do its movement.

The markets effectively breathe up and down, you have traders on both sides of the market making it move so you’ve got to allow for these movements down, they’ll come up to resistance points and prior highs, they’ll come off the prior high, it doesn’t mean to say that the move is over it just means other traders will sell into that point because it’s been there before.

As you can see in this case it has a little reaction and then pushed on and broke it. So it has pushed up and consolidated around this area here, pulled back, found some support here and it’s only when it breaks this level here that I then feel like you should be moving the stop up to the lows here.

Price pushes up, it pulls back, it breaks that level and runs up to here, at this point we can move the stop up to this level. Let’s say we’ve taken another third off because we’re feeling bullish because there’s a good trend and we want to try and run it further.

As soon as it’s made this high and pulled back and broken that high I can move the stop quite aggressively and just get stopped out. Okay I didn’t make quite as much as taking two thirds off here but there’s always the opportunity that it could run further. So it’s just about using your stops creatively.

Hopefully that all makes sense, I will show you two recent examples of trading. There’s nothing on here to show you why we got into the trade at this level but we did. There were certain setups occurring and we had a good probability trade. The target was a high percentage to get down to these levels and the stop was just over the highs.

Reasonable risk/reward and there was opportunity to go a bit further down here. So we had that target and there was another target just shy of that so there were certain opportunities. This one was had an 80% chance of being hit.

So we got into the trade, it went down very quickly and hit the target, this makes it look like it went a lot quicker than it felt but sure enough it went down and caught the target. We were looking to run some. This was a two-thirds off trade because we’d already moved from the morning quite a long way. It then had a little bounce and the stop was so far down and the logic was moving the stop to breakeven so it was a no lose trade.

Then it broke down and broke the low here, so it gave us an opportunity to move the stop down here. The market then came down further, it came within and broke those lows there. As it broke those lows we could have moved the stop down there. As it was I came out near enough the low there.

Conditions had changed, there was support there which could have changed things and did after a while but there was no point in me sitting in there with the opportunity and the risk of it running up, which it did come up to test those regions but has not broken them so taking the exit there was fine.

If I’d trailed it down I could have trailed it there and I wouldn’t have got another opportunity to get it any lower than there without it stopping me out. It’s just an example of how you can do it.

Now an example of how you can fluff it…

This was yesterday on Cable. I fluffed it by being a bit too aggressive. At this point it was 20 pips up and I said I was going to be aggressive, it’s moved down quite nicely, I’m going to be a bit aggressive and move the stop down to breakeven. I moved it from where it was down to that breakeven point just a little bit too early. It just ran through the aggressive stop, making us nothing.

It was just a case of us sitting there and being a little bit too aggressive. Could have changed, I always look and review what I could have done better. I could have left the stop alone and walked away and I had a good target that it eventually came down to.

How could I have managed it? Just using principles in terms of saying that it made a lower high but it’s very easy in retrospect but I think it’s important that you learn from doing something for the wrong reason.

It could have been that the little divergence could have got us to breakeven, but whatever. Even if I’d put half of it to breakeven and left the other half then the other half would have been doing very nicely eventually.

Where do we go next? Let’s assume I’d been cleverer and left the stop where it was, only when it’s broken this level here do I start actually moving the stop down, and not necessarily to breakeven. Let’s put this low in here, so that’s a lower high from the prior highs it would have run up and broke down again but this is easy because it’s just broken through this low here so I can move the stop down here.

Next it breaks down and pulls up but it doesn’t make a new low so I can’t yet move the stop. It’s only after it’s broken this low can I then move the stop down to here which is not that significant.

I can’t remember the exact level but it wasn’t too far below here which I’d have been taking a good amount of profit off at this point as a good target area to be aiming for. After that it’s just a case of managing the position. It would have been a while before I could have moved the stop from this low here using this method.

It may be when it’s just done what it’s done there and it’s finding support, you say, I’ll just start tracking it using a two bar method. So start tracking it down quite aggressively. As it goes down move it two bars below the action as it runs down and eventually you’ll get stopped out.

That two bar method works in a very fast moving market if it’s a bit more choppy then you’ll be chopped all over the place.

This move yesterday by waiting from the lows to be broken you could have started moving the stop down even more aggressively. You wouldn’t have moved it much further down, by twelve o’clock the target would probably have been hit.

That’s the principle behind it, I hope you find it useful.

4 Comments

  1. Mike Haran-Reply
    July 10, 2015 at 10:09 am

    A really nice video Kym,

    I have to hand it to you this was well explained and well thought out. Excellent work and well done for making such a good and informative video.

    • Kym Watson-Reply
      July 10, 2015 at 12:25 pm

      Thanks Mike glad you found it useful.

      Best wishes

      Kym

  2. Karl-Reply
    July 10, 2015 at 9:43 pm

    Great video Kym! What do you think about using the ATR for stops?

    • Kym Watson-Reply
      July 11, 2015 at 4:46 pm

      Thanks Karl.

      I believe the ATR is very useful with calculating stops. On shorter time frames you could consider using a multiple of the ATR for a stop.

      I use it for an initial stop on one of my swing trade strategies.

      Best wishes

      Kym

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