In our last email we showed you how to hedge your bet after entry to ensure the highest percentage of winners.
Now that you know how to hedge your bet after entry to ensure the highest percentage of winners you will want to know how to achieve the lowest initial risk for your trade.
Regardless of whether you are a position trader or a day trader, you probably use protective stop loss orders. If you aren’t using them, you need a safety net. The lack of a Stop Loss order indicates a lack of confidence in your trading approach, so it should be automatic for you to immediately place a stop loss order after your trade entry is filled.
The TradeSafe System automatically parks a standard stop loss order immediately after your entry is filled.
Additionally, that stop loss order is bracketed with your target in what is called an OCO or “one cancels other” or “order cancels order.”
The purpose of an OCO order is to protect you from forgetting to straight cancel one of the orders if the other one is filled. When I was a beginning trader, I had a winning trade but forgot to straight cancel my stop loss order afterwards.
That stop loss order remained active in the market after I had turned off my computer, and when I checked my statement the next morning, I was more than $4000 underwater! That resting order got filled and the market went against me even though I was unaware of it. That was a very expensive lesson!
The TradeSafe System automatically creates an OCO bracket order for every trade you take. That way, you are protected against inadvertently leaving an active order in the market.
So far, we’ve been discussing the process of stop placement and subsequent actions like the above-mentioned OCO order. How do you keep your initial trade risk at the smallest possible price level?
By utilizing what are called Logical Stops you can avoid the one-size-fits-all approach of using fixed-dollar stops.
Nearly all traders tend to use a fixed amount of risk that they are willing to tolerate for their trades. They are unnecessarily risking more than they need to. Instead, they can achieve a variable level of risk that depends upon the size of the setup bar for their trade.
In an earlier blog post I covered the optimum way to pinpoint your entry with great accuracy by trading pullbacks or retracements in a trend. Please refer to that earlier post for more detail.
When you have a pullback or retracement in a trend, the last or deepest bar in the pullback itself is called the setup bar. As described earlier, before the close of that bar you would park a resting stop limit order and let the market prove itself by snapping back in the direction of the trend.
Once the trade is underway, the bar that was your set up for your entry is now the deepest point in the pullback and would be considered a classic pivot or swing. Basic technical analysis tells us that if you are in an uptrend, for example, and you have entered a trade after a pullback, if price were to later trade back below that swing low pivot you would be penetrating a support level.
The low of the setup bar itself, which forms the bottom of a classic V-shape pivot or swing, acts as a support level for that chart. If price trades through it and continues below it, then the trend is no longer up. By definition, the trend is now down.
Therefore, why would you want to remain in a long position if the trend is no longer up? This is why the term Logical Stop is used when you place your stop loss order one tick under the low of the setup bar.
This opens up the possibility of having a variable amount of initial stop loss risk because the range of the setup bar dictates how far apart the entry order is from the stop loss order. If you have a large range bar, the distance between your entry and your stop loss is greater than if you had a smaller range bar. Thus, your risk depends upon the range of the setup bar.
This is how you can achieve very small risk levels for your trades. Assuming you have a maximum amount of risk that your trading approach or system allows, you will know that any trade you take will never exceed that maximum and can often be less if the range of the setup bar dictates it.
In the TradeSafe System, when trading the Indexes (minis), we allow a maximum risk on a per contract basis of only $70 when we use a scalping exit strategy. Of course, if the setup bar is smaller, the risk will be less than $70 per contract.
When scaling out we allow up to a maximum of $100 per contract traded, and again, the risk can be less than that if the setup bar’s range dictates.
By using Logical Stops, you can control your risk levels much better than using a standardized fixed dollar stop amount.
Stay tuned for next week’s installment to learn more about how to still be able to take trades even in today’s high volatility conditions.
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