Getting the direction of the market right is only part of the challenge you face as a trader. The other has to do with money management.
Managing your 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 Traders Whiteboard lesson we are going to focus on STOPS!!!!!
There 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 once joked with me that he had never seen a "mental stop" filled in the pits. It's true, for stops to be effective they must be in the market in the form of an order.
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 stopped 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 more importantly to protect capital.(1) A dollar stop, is when you set a predetermined dollar amount on any trade. Let's say you want to risk $500 on a grain trade or $750 on a stock trade. Once you get your order fill back from your brokerage company, you simply subtract out from your purchase price the amount of money you have determined beforehand that you wish to risk on this trade. The reverse would be true if you were shorting the market.
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 avoiding BIG LOSSES. A 1% loss is easy to absorb. A 30% or 40% loss is an account killer, that can, with this strategy be avoided.
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 point. The good thing about a chart stop is that this level is often used by other traders. That can be both a good thing and a bad thing, here's why. Using either stop (1) or stop (2) only you know where your stop is. With a chart point, a great many traders/brokers know where the stops are. In an illiquid market this type of stop should not be used as many times brokers gun for the stops. "Traders Tip," avoid thinly traded markets like the plague.
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.
Use stops... put them to work for you today
When I was a kid growing up in England, all I needed to be happy was a piece of paper and a pencil.
