Last week we posed the question ...
Can an egg timer improve your trading?
For many of us the answer is NO.
So what can improve our trading? We know that the market can do only three things right?
It can go up, down or sideways.
That's it, end of story.
Getting the direction right is only part of the challenge you face as a trader. The other has to do with egg timers, or more specifically money management.
Managing you capital or the deployment of capital is one of the most important items on your trading list. Yet it somehow falls between the cracks for most traders.
In this weeks blog posting we are going to focus on STOPS!!!!!
Stops are enormously important part of a traders arsenal of trading tools. Some traders confirm that stops are the most important part of their trading armour.
So here are three ways to use stops to protect your capital and lock in profits from a trade. These three money management techniques can be used in stock, futures and forex trading. The important rule is that you do use a real stop in the marketplace. A friend of mine joked with me that that he had never seen a "mental stop" filled in the pits.
If the market is good your stop will not be hit. If the market is bad or changing direction then you'll want to be out of it anyway. That is why stops are so crucial to trading success.
Here are the three most commonly used types of stops. Which one do you use?
(1) Dollar stop.
(2) Percentage stop.
(3) Chart stop.
If you chose (1) you'd be correct, but, you would also be correct if you had chosen 2 or 3. All three are money management stops and are used to either lock in profits or protect capital.
1) A dollar stop, is when you set a predetermined dollar amount to a trade. Let's say you want to risk $500 on a grain trade or $750 on a stock trade. Once you get your fill back from your broker or electronically online you simply figure from your fill price where to put your stop.
Pros: Easy to implement and use.
Cons: Can place stops too close in a volatile market
2) Percentage stop, is a very simple way for you to place a stop on a position. Here's how it works. Let's say your trading account is 100,000 dollars and let's say you only want to risk 1% of your total portfolio on any one trade. You simply take a $1,000 risk which represents 1% of your over all portfolio. This can help enormously in taking BIG LOSSES. A 1% loss is easy to absorb. A 30% or 40% loss is an account killer and can and should be avoided at all cost.
Pros: Easy to implement and use.
Cons: Can place stops too close.
3) Chart stop, a chart stop is where you place a stop that is either above or below a crucial chart level. The good thing about a chart stop is that this level is often used by other traders. That can both a good thing and a bad thing, here's why. Using either stop 1 or 2 only you know where the stop is. With a chart point a great many traders/brokers know that is where your stop is. In an illiquid market this type of stop should not be used as many time brokers gun for the stops. In a highly liquid and active market this is a good stop to use.
Pros: Very easy to implement and use.
Cons: Can't be used in thinly traded markets.
So there you have it. Now you have all three ways to manage your money and protect your profits at the same time.
Some say stops are for wimps, or "if I put my stop in the market they will only stop me out". In big liquid markets nobody is big enough to make their presence felt for more that a day so no one is going to stop you out.
Use stops...they let them work for you.
Next wee: DIVERSIFICATION how to get and how to use it. Find out how diversification can lower your risk while increasing your returns.
See you next Friday.
Have a great weekend and trading week.