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STOPS and EXITS  by  Buffy                                               

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This Article originally transmitted in January Issue Ensign Software Newsletter, a great source of information. Check out all the past newsletters.
Trading Tip:
Stops and Exits
by Judy MacKeigan

Let me start out by saying that there are almost as many ways of using stops as there are trading methods.  In my opinion it is the most personal part of your trading system.  Each trader needs to determine which method they want to use for stops and still be within their own comfort zone.  If you are outside your comfort zone, then emotions are in position to take over and you will lose the focus you need to manage the trade correctly.

You should never enter a trade without having a predetermined place at which you will cut your losses.  Yes, you will get stopped out only to watch price take off like you thought it would, but that is part of the game we are playing.  If fact, if you do not have the right mindset for taking a loss, it will hinder you from becoming a good trader.  Getting upset over it only takes away from you ability to focus on what the market is telling you.

Many traders also feel that getting stopped out is a loss.  It really isn't.  In fact, you have won.  By being stopped out, you have won most of your money back.  Preservation of capital is so important to be able to continue to play this game.  You also have the ability to reenter if price does eventually go the way you thought it would.  Lastly, you have eliminated the frustration of not being disciplined by getting out when your predefined stop hit.  One of the signs of a successful trader is having small losses and not huge ones.  Think of that the next time you do not exit immediately and without hesitation when your stop is hit.  Losing properly requires skill, discipline and maturity as a trader.  Some say a stop is like insurance.  A trade without a stop is a gamble.

As a trader, you need to ask yourself if you are going to use the same time frame for signals, entries and exits or go to a lower time frame for the entries and /or exits.  This is a common practice but hard for beginning traders to do as they tend to focus on the lower time frame instead of waiting for the signal to setup on the main time frame.  Once you have learned to do it though, it should improve your results.

One of the most common ways to determine your stop loss is to use the preceding price bar or the price bar you were filled on.  Which one is used is nothing more than a matter of traders preference.

If you are entering a long above the high of the previous bar you may:

  1. Use the prior bar stop -- place an initial stop 1 or 2 ticks below the previous bar's low.
  2. Use the current bar stop -- place an initial stop 1 or 2 ticks below the current bar.

Some traders use a combination of both by normally using the prior bar, and then if the risk is too high for their rules, instead of passing on the trade, seeing if the current bar method brings the risk back into range for their trading rules.

Using this method for when price is in a trading range:

The stop can either be at the low of the range when long, high of the range if short.  Or if risk is too high then the High/Low (H/L) of the breakout bar can be used.

Another problem can be created by runaway price creating a long bar when you are in the trade and using the H/L of the bar would be giving a lot back to the market.  For this situation, I still use what Mike Bruns taught, which is not to let price get more than 2 points away from your stop.  This assures you of locking in profits while still giving it some room.

Those of you who use Fibonacci levels might use price targets to exit with.  

This excellent chart posted by Scorp shows two measured moves (blue lines).  Marking measured moves shows how price moves the same distance after pausing.  This chart also shows how Fibonacci projection of 127% worked again.  A measured move is when price moves up or down then pauses either with retracement or sideways consolidation and then takes off again in the same direction.  The first move up or down more often than not matches the second move up or down.

The Ensign Windows draw tool used for the measured move in the example is the Formations tool.  On the tool's property window check the first three lines, and have the C-D leg parameter set at 100 so it is drawn at 100% of the size of the A-B leg.  You draw three points, A, B, C and the tool will measure the leg from C to D.

Q:  On your first chart, do exit once the stop price is hit or when the 2min candle is complete which close at or beyond the stop level? Remember, these candles are changing dynamically.

A:  I personally do not wait for the bar to complete, but then I am not trading off of the 2 minute chart.  If the low of the prior bar is my stop then I am out.

Q:  What's a hard stop?

A:  A stop that is actually entered with the broker is a hard stop.  It isn't mental.  Until you can trust yourself to execute a mental stop without hesitation, I recommend you use hard stops.   A hard stop is great to have when the power goes down

Price target can also be done with price patterns.  Some examples are head and shoulders, triangle, and wedge,

This chart shows how to project a target from a head and shoulders price pattern.  Many price patterns have their own rules for projecting price targets.

Other traders use stops to determine when to exit a trade.  We will mention many of them but I am also sure there are many more out there with new ways being devised all the time.  Some prefer to use trailing stops.  In my opinion, for this to work well, you need to find a "smooth" chart.  By this I mean where most of the bars in an up trend have higher highs -- HH -- and higher lows -- HL.  This will help prevent you from getting stopped out on small price movements within the trend.  Which chart is "smooth" can change during the course of the trading day.

Once you determine this, it is now possible to use the prior bar or two bars ago H/L as a place to put your stop.  If the prior bar, you may want to add a tick or two if the trend is strong.  You can also use a larger stop in trailing price.

Another technique is to drop to a lower time frame and put a Simple Moving Average (SMA) on the highs and another one on the lows.  The chart example uses a 5 period SMA on each.

The upper red line which is a 5 SMA of the highs would be used as a stop for a short.  The lower blue line which is a 5 SMA of the lows would be used as a stop for a long position.

Another method is to use the last swing high for shorts and last swing low for longs.  The following chart gives an example of using last swing highs for a short.

Many charting programs have a study called Parabolic Stop. This chart shows an example.

A big volume spike is reason enough for some to exit as this happens when there are traders taking their profits because they feel the move is over and other traders are buying to play the price movement in the other direction.  For many traders, the candlestick pattern gives them the signal to exit.  These reversal patterns can be found at www.litwick.com under glossary.

Another effective stop method is the high/low stop, which much of the time is the last swing high/low but tightens on a longer move.  The High/Low stop is the highest high or the lowest low of the last N bars, plus or minus a slack offset.  The slack is added to the high of the last N bars, or subtracted from the low of the last N bars.   The best slack value to use can be determined by back testing.   A value to use for N would be in the 3 to 5 bar range.

As you can see, there are many strategies out there.  Find one that is in your comfort zone to use consistently and your trading results should improve.


Copyright 2003 - Ensign Software


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