Wednesday, 24 December 2014

Trading Education- Stop Losses and Profit Targets

Newsletter 46

Basic Trading Concepts Defined

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Stop Losses / Profit Targets

One of the great tricks to trading is letting winners run.

The best way to do this is to take 2/3rds of the trade off at the 2-reward level per risk (i.e. twice your stop loss), then trail the other 1/3rd.

For instance, let’s say you are trading the micro account again.

·       Enter your trade for 3 micro lots (3,000).

·       Place your stop at 80 pips for all 3 micro lots and place your profit target at 160 pips for 2 of your micro lots.

·       If you hit your profit target, you have closed out 2/3rds of your position for 160 pips.

·       Then move the stop loss up to 80 pips profit and leave the trade alone.

·       Every time it increases, move the stop loss up another 80 pips.


Now the maths:

Initially, calculate the average if your position retraces from my profit target and you had moved your stop to 80pips:

(40% x ((160 + 160 + 80) / 3)) – (60% x 80) = 53.34 – 48 = 5.34

Then think about what could happen if you trail your stops higher.

If the trade actually runs up and you get stopped out on the final 1/3rd at 160 pips above your initial target of 160 pips, that’s 320 pips:

(40% x ((160 + 160 + 320) / 3)) – (60% x 80) = 85.34 – 48 = 37.34

You are starting to see how you can quickly increase your average with a few good trades that continue in your initial trade direction.

The final trick to employ, which many people find hard to do, is adding to your position. Say you are in a trade, and that you need to see three moving averages cross in order to go long.

Take your initial long position with 3 micro lots, 80 pip stop, 2/3rds of your trade with a limit order to take profit at the 160 pips, 1/3rd being trailed at the 80 pips mark. If you hit your target at 160 pips, there is a small retracement and you will get another entry signal when the three moving averages cross again.



It may seem obvious, but what you need to do is take the trade again, as if you didn’t have a trade in place already. In other words, go long again 3 micro lots and place your stop at 80 pips (still trailing the other stop), your 2 micro lot limit order profit target at 160 pips, and look to trail the final micro lot.

This way, if there is a continued trend, you continue to build a bigger position at a better price (due to averaging of prices), so that when it finally reverses all of the 1/3rds trailing stops that are in the money, and that get stopped out, will be of a considerable size.

Applying these three rules can turn anyone from a losing trader into a great trader. The key is to stop trying to be right, and start trying to be profitable. 

Reference: Investopedia

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