Did you think about Risk/Reward? Did you look at your win/loss percentage to see how good you are at picking the direction? Some folks are very good at picking the right direction but most are not and as long as you know where you stand on that scale from good to bad then you can tailor your trading to your specific risk/reward needs. There is another issue that comes with this concept and that is how consistent is your win/loss percentage? As you trade more and gain more experience you may find that your win/loss percentage will change and then you must be able to recognize that and adjust your setups accordingly. This problem is also held at bay by instituting a minimum risk/reward ratio and that minimum is 1 to 2, meaning that we need to at least have the ability to earn two times the reward for the risk we are willing to take.
Last week we talked about how we come up with the numbers to determine risk and reward and that comes down to our SET principles. Our SET principles are what give us our initial trade entry numbers. So in this week’s diddy we are going to look at some of our rules for each item in SET, that is our Stop loss, Entry and Target numbers.
First up is the Stop Loss. When setting a stop loss we need to have specific rules for different types of trades. For example, if we are entering on a bull retracement we will want to put our stop loss in at say 10% of the ATR(Average True Range) below the low of the previous days’ candle. Take a look at the chart of AAPL below and you will see the bull retracement circled in yellow and the Stop Loss line in Red.
The red arrow is the price point at which we are putting our stop loss in. This is the math in which we use to derive that price.
ATR = $4.04
10% of the ATR = $4.04 x .10 = .404
The low of the preivous candle was $172.66. Therefore are stop loss price = $172.66 – 0.40 = ~ $ 172.26.
This is one of many techniques that you can use for you stop loss. The important thing is that you use a stop loss and it also helps if you stick with one technique to prevent confusion and prevent from over-thinking on your trade setups. Having too many choices can be a bad thing sometimes. Having said that there is another stop loss technique that I find valuable and that I know a fair number of folks use.
The second stop loss technique is 1/2 ATR under support. This works well if you are seeing a solid level of support and you are entering a trade above that support level. Take a look at the chart of AAPL below.
From this chart, you can see a very solid level of support at the 165 level, I have circled the support in yellow. This stop loss technique is quite simple after you identify the level of support. You want to ensure that the support is a key level of support. Key levels of support are more important than any other kind of support, these key levels can be identified but the number of times that support comes into play and they also occur quite frequently at 5 and 10 dollar levels which we can see occurred here with AAPL at the 165 level.
The math for this stop-loss technique goes a little like so…
ATR = $4.44
1/2 of ATR = $4.44 / .50 = $2.22
Therefore the support level is $165 – $2.22 = $162.78. This is your stop loss price point. You can see this is a pretty easy way to put in your stops. When we take the price point and minus it from our Entry price then we have our overall risk. That is the first part of figuring out our risk/reward. Next week we will go through our Targeting techniques and then we will have a complete set of rules to determine our risk and reward and then we can begin to put our trades together.
So practice your stop loss techniques and find the one that is right for you and then make sure you stick with it and always put on a stop loss it will ensure that you get to trade for a long time.
