Risk Management in Trading part 2

Fear is of incurring a major loss

The other type of fear is of incurring a major loss. It is done with a stop order. The stop order lets the investor take comfort in the fact that if his appraisal is badly flawed, his loss will be cut short before it turns into a disaster

If a trade has been made too early (FOMO), the stop may be too close to survive the remaining and unknown action of the trading range. In these cases the position may be lost to a stop resulting in a loss even though the eventual outcome has been properly diagnosed market.

  • Using a stop correctly means maintaining a profit – risk ratio that is in your favour. Be careful however, that you don’t end up using this idea in a way that unduly restricts the stock’s ability to move.
  • Over the years we have found that the most generally acceptable profit – risk ration is 3 to 1. First of all, it prevents a major loss it also gives the stock some breathing room. It is unreasonable to assume that every stock will be caught exactly at its turn.
  • A long position may move somewhat lower before it turns up and a short position may move somewhat higher before it turns down. You have got to allow some margin for error.

Stop loss order

How to place a proper stop loss order?

Step 1 =Identify the structure of the markets

Step 2 = Place your stop loss beyond the structure

Let me explain…

Identify the structure of the markets

The structure of the market refers to Support & Resistance, swing high, swing low, higher highs and lows, lower highs and lows, and etc.

Step 2 = Place your stop loss beyond the structure

These are important points in the market because that’s where most traders will place their stop loss.

Why?

Because if price trades beyond it, it will invalidate their trading setup as they know they are wrong on their trade. But, the problem with placing your stop loss near these levels is, it gets triggered easily by smart money

Why they do this?

Smart Money paid to collect VOLUME (where Liquidity is found). He only targets places with higher Volumes are and he collects them.

How they do?

They spikes in one direction or the other hitting the stop losses of either sellers or buyers

Protection against greed

Greed is perhaps more basic. When it is responsible for a loss it is a loss of already realized profits

From an objective standpoint you would think that when a reasonable profit has been developed in a position there would be a great deal of satisfaction in taking of that profit. Unfortunately, it doesn’t always work that way. Let’s analysis the situation

  • After market given a certain level of profit there is a tendency to want more (greed) instead of being satisfied.
  • The desire to have more profit causes the situation to be analysed from that standpoint (greed) and not from the standpoint of things as they really are. At that point greed has taken control and the profit already gained is put in jeopardy
  • Consider these examples. A stock is in an uptrend and has been for quite some time with good upside progress being the result. There are two good reasons here for selling this stock .The stock becomes overbought, reaches its upside objective or key resistance
Here’s an example for Risk Management in Trading:

You go long on a breakout and the trade goes in your favor immediately. Shortly, you have open profits of 3R and your trading strategy tells you to exit your trade (because the market has reached a key Resistance). But, you tell yourself: “This chart is looking so bullish, I should hold this trade longer for bigger profits”. So, you hold onto the trade. Slowly, the market starts to reverse and wiped out a portion of your open profits. Now you’re feeling anxious but you tell yourself: “Never mind, I’ll exit the trade if the market goes up a little more”. Unfortunately, the market didn’t go higher and retrace all the way and hit your stop loss.

How to overcome greed
  • Pre-establish a sell or cover order in the area of the anticipated objective
  • Or once price is reached in the anticipated objective , tighten your stop loss(trailing stop order)
Pre-establish a sell or cover order in the area of the anticipated objective
  • The only way to totally protect oneself from greed is to take steps against it at the time a position is one of the best ways to do this is to predetermine and preestablish a sell or cover order in the area of the anticipated objective. When the stock reaches that level the established. Position will be automatically eliminated and the profit protected.” Greed won’t even have a chance.
TRAILING STOP ORDER

We identify zones in which we’re happy to trade, and then work the best entry we can within that area. Stops should be placed in a location that invalidates the trade

Not every position is going to make it to its indicated objective. I mean not every position hit the target. In those cases where the ultimate objective is not met, how to protect the position? The stop order can be used very effectively for this type of protection providing. If it is used correctly throughout the life of the position.

That means re positioning it as the move progresses. The first objective in re positioning a stop is to get up to or down to the trade price as quickly as possible. One this is accomplished, the investor’s funds are protected against loss and he can breathe a little easier. This re positioning, or any to follow, cannot be done in a careless fashion. If it is, initial capital may be protected, but profits will likely be scarce.

The rest periods between the periods of progress are extremely important. They will indicate when a stop can be moved and more importantly to what level it can be moved. A resting period will either come as a normal correction or as a horizontal consolidation. The stop should be re positioned just above or below the extremes of these periods just as soon as there is an indication that the prior progress is being renewed. Don’t be in too much of a hurry on this. If you cannot point to some action that clearly indicates the prior move is about to be renewed, you may be setting yourself up to be stopped out by a correction that goes a little farther than you had expected or by the consolidation that ends with an unexpected shakeout or up thrust action.

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