A guide to stop loss placement

A Guide to Stop Loss Placement.

Where to place our stop loss can be as complicated as you make it. Lots of traders try to get too cute with placing their stop losses and this is where some traders can become unstuck. Giving trades the right amount of space to breath is very important. We cannot expect the market to move continuously in one direction and so we have to be prepared for price to reverse when we are in a trade.

The use of stop losses plays a vital role in protecting ourselves from large losses in the forex markets, to trade without stop losses would be very risky indeed.

We also use stop losses to establish the amount we want to risk per pip on each trade.

So say we had a 100 pip stop loss and wanted to risk £500 on the trade, we would open a position that risks £5 per pip.

Now a lot of traders get put off using large price action candles to trade from because the stop losses will be large. This shouldn’t be the case, we just need to reduce the amount risked per pip to compensate for the larger stop.

So if the stop loss was 200 pips and again we wanted to risk £500 we would instead open a position that risks £2.50 per pip.

The simplest way to choose your stop loss placement before entering a trade.

Now I use a very simple method and it involves asking ourselves before we enter a trade, “where if price does manages to reach a certain level will the chances of price continuing against us be high”

Usually, I would say the range of the price action setup candle is a good place for our stop loss. So if we are going short off a price action candle the high is the logical place to put our stop loss. This will give the trade the room to breath.

If price did manage to break the high of the range of the price action setup, the chances price will continue on up is very high and so I am happy to be out of the trade but also knowing I given the trade the most space possible to see if it can work out.

However, if the price action setup candle is extremely large in size, placement of our stop loss using the range maybe too much. Very large price action candles indicates large strength and momentum, so after a very large candle forms price can do two things:

1. Continue on in the direction of the momentum.

2. Due to the largeness in size of the price action candle and the distance price has moved in a short space of time, price may instead reverse as traders close their trades to take some profits. This allows the traders who missed the boat the first time a chance to jump onto the trade with a retracement of price back to value.

Therefore, if after a very large candle forms and we do see price retrace we need to ask ourselves where will price most likely get to and then get rejected strongly. The answer for me would be at a key level.

If a price action candle very large in size has a key level within its range, that key level should have a strong chance of repelling price back in the desired direction. So hiding our stop loss in this area makes sense.

I tend to avoid putting a stop loss any lower than the 61% fib retracement level of any price action candle though, as I feel reducing the stop loss any more is too risky and does not allow enough space for price to breath. Even if a key level sits around the 38.2% fib retracement, I will still keep the stop loss beyond the 61% fib.

Does the trend matter?

A factor that can also help us in placing our stop loss is what the current trend or momentum is. If we are intending on taking a trade with the current momentum then it seems logical to assume we can be a little more aggressive on the stop loss placement.

Taking trades against the current momentum (counter trend trades) is more like trying to swim against the tide, the chances of more chop and resistance is much higher and we should be prepared for a rockier ride. Therefore, the chance that price will go sideways or retest a key level is much higher and so using an aggressive stop loss will not allow the trade the space to breath.

Thus, stop loss placement must involve the use of logical levels to help us make our decisions. If we are unable to determine a key level that maybe used to reduce the stop loss then the candle range is to be used.

Most of the time I use the range to place my stop loss but if we get a really large candle and a logical place to hide the stop loss, I will do so. Remembering to factor in the current momentum as a point to consider.

Stop Loss Management.

Once we get into a trade and it moves off nicely from our entry point the next question we have to ask ourselves is, when do we get to break even and how do we trail the stop loss to lock in profits?

Moving to break even.

The first thing we need to decide is when to get a trade to break even, I personally like to do this as soon as the first trouble area is hit (Check out the article “Why do trades reverse against us?”). The reason being I’d much prefer to be taken out of a trade at break even rather than have a full loss. If we ignore the possibility a trade has the potential to reverse against us, we expose ourselves to a lot of losing trades.

Some traders ignore the first trouble area or don’t even know it’s there but I truly value this information and it will definitely reduce the number of full losses you incur.

Stop Loss trailing.

Now locking in profits is always going to be an area you feel you can do better in but remember there is no technique out there to lock in every single pip on every trade, it’s just not possible. So beating yourself up if a trade moves another 500 pips without you, after your stop loss gets hit is pointless.

If you stick to your trade plan which you decided before entering the trade, you can do no more and you should be proud of yourself for having the discipline to follow the plan through.

The options for trailing stop losses are many and varied, I will go through a few to give you some ideas, but this is all down to personal preference.

1.      1.Two bar trailing stop loss, now this is a simple technique whereby you place   your stop loss, 2 bars behind the current candle. It is very effective with trend trades and can keep you in trades to get those runners.

2.     2.Using the most recent swing points, again this is a simple technique where you use the most recent swing points to hide your stop loss. This is for the braver trades who can handle price pulling back large distances against them.

3.     3.Using the most recent levels broken to hide a stop loss. This being my personal favourite.

4.    4.There is also an option to use price action to help us with stop loss placement.

An example here would be if we were short on a pair and a large bullish engulfing bar (BUEB) formed, now we know if the bar is large it could result in price continuing against our short position. Therefore, a simple way to cover our trade is to place the stop loss just above the high of the BUEB. The reason being if price does manage to break higher from the BUEB we get taken out and lock in some profit. This type of stop loss placement modification needs to be used with strict rules though. Making sure we only modify our stop loss if the reversal setup is large and valid, this is not to be used on tiny weak price action setups.

It’s down to you!

How we manage our stop loss trailing will have a direct impact on how much profit we can take off the table. I like to be more conservative with my stop losses and take profits and so am happy to have smaller yet more consistent profits rather than hoping for those illusive runners that are so attractive to so many traders.

I hope this may have given you some ideas on where and how stop losses can be placed. Unfortunately, there is no single method to handle placement and trailing of stop losses, it all comes down to what works best for your own personal trading.

An important note, is to decide all of this prior to entering trades. Making decisions about placement and trailing of stop losses on the hop whilst in a trade is never going to produce consistent results and just gives you an unnecessary trading headache.




Author.
My name is Jeremy Poor, I am a professional Forex trader and my aim is to help aspiring traders to learn all about trading the Forex using Price Action  and where to look and hunt for the best trades. With lots Forex articles, videos and a dedicated  price action forum to look at, its a great place to learn how to become consistently profitable at trading the Forex.

Does size matter?

Does size matter?

This is a very important question. I see a lot of traders focus their attentions too much on the structure of reversal price action setups and forget the most important part of a reversal price action setup - the size of the price action setup.

What does the size indicate?

It’s very simple, when we see a large candle stick being printed it indicates a strong momentum. This informs me where the market wants to go. Using the logic that price is unable to continuously move in just one direction we have to expect price to reverse at some point, to get back to value.

The reason why price does reverse after a strong move is because of the traders who entered the market in that direction will look to take profit. The only way to do this is close out their trades and thus explaining why price reverses.

When price does reverse and traders take profits, we can expect to see price action reversal setups such as pin bars and engulfing bars to form. Now, these price action setups can be a bit misleading and is where traders can get a bit unstuck because they confuse profit taking signals with signals that indicate changes in market momentum.

The difference between profit taking candles and changes in momentum candles.

The main difference between the two types of price action setups is again down to the size of the setups. If the price action is larger in size than the surrounding candles then to me it indicates a change in momentum could be on the cards. Small sized price action candles are just that, small price action. Take a look for yourself at say a 4hr chart and see how many small pin bars get printed. Being selective and choosing only the large sized candles is what makes us stands out from the crowd.

Using the size of the price action setups to guide us is a great rule to have because it makes us only take the price action setups that have a high probability of coming off. This also reduces the number of trades we take, which is no bad thing because our win rate will increase.

Taking small price action setups like small pin bars is something I see traders do all the time and yes it’s great when they come off because the small price action setups result in smaller stop losses and in turn greater risk reward potentials.  This though in my experience will be short lived and taking these types of trades over a long period of time will be produce weak results and a poor win rate.

The only way you can make this type of trading work is if you can make your winners big because the number of losing trades will be high. Feeling like you have to maximise those winning trades and catch big runners to make up for the losses is a hard call and exerts a lot of pressure on traders.  We all know what happens when we get into pressurised situations, we tend to make mistakes and because the Forex markets allow for very little mistakes. The punishment will be seen in our accounts.

Before entering a trade.

So the main question I ask myself before entering any trade is –“does this price action candle stand out from all the other surrounding candles”. Better still consider if we moved forward a year and we looked back at the chart, would the price action you are considering to trade pop out at you and say “TRADE ME”.

If the answer is no, then it’s a simple pass and move onto the next potential trade setup.

The number of trades we take does not directly correlate to the growth of our trading account.

Traders can feel pressured into taking high volumes of trades each month to validate themselves as traders and this is where problems can arise.

If we focus on only taking the very best high probability trades we will increase our win rate, the number of high probability trades that do form can be low in volume each month and traders can find this hard to understand.

I myself used to think that the more trades I could take each month the more money I would make.

The problem is to get into more trades each month means we have to reduce our standards of what a valid price action setup is.

Let’s look at an example of two traders who have different win rates and take completely different quantities of trades each month.

Trader 1, takes on average 20 trades a month but has a win rate of only 30%, so 70% of the time the trades taken will be losing trades. Trader 1 risk 2% on each trade, 14 trades will be losers and so each month will be down by 28% each month.

To break even each month the 6 trades that will be winners have to return over 4.6% each (requiring at least a 1/2.3 risk/reward). This is a lot to ask and to make say 10% profits each month those winners will need to return around 6.5% each (1/3.25 risk/reward).

I fancy this trader will have to learn very quickly not to let losing trades effect their strategy, being used to having more losers than winners is hard to take.

Now trader 2, on the other hand is a lot more conservative looking to take only the very best trade setups and so on average only takes 4 trades a month. Trader 2’s win rate however is much higher at 80%. So on average this trader will have 3 winners and 1 loser each month, again the risk per trade is 2%.

The results speak for themselves, due to the lower number of losing trades the losses per month will only be 2% and so putting a lot less pressure on the winning trades. Therefore, even if the winning trades only produced say 2% returns each (1/1 risk/reward), the trader would still be up 4% per month.

To make 10% profits each month, the winning trades would need to return on average 4% per trade or a 1/2 risk/reward. Therefore, asking far less from the markets to still make a healthy return each month.

Trader 2 is therefore in a much better state of mind, their accounts will have much lower drawdowns and will be experiencing the feeling of taking winners much more frequently.

This isn’t the end of the story though because trader 2 who takes less trades per month is in a much better state of mind and is able to consider increasing the % risked per trade. Trader 2 decides to up the % risk per trade to 5%.

Using the same figures as before, trader 2 will have a 5% deficit to recover each month but the 3 winning trades now will return 15% even if the winners only return a 1/1 risk/reward. Totalling 10% per month profits.

Therefore, taking less trades per month and having a better win rate means that:

1.       We don’t need to take huge numbers of trades per month

2.       We are in a better state of mind and so increasing the % risk per trade is a viable option, this means we can increase our gains per month but having no impact on the quality of the price action setups we take.

3.       Account drawdowns are low and so we are not under pressure to make our winning trades massive runners.

4.       Plus our profits per month will be more consistent.

Conclusion.

Trading doesn’t have to be full of stress and complicated decision making processes. Having strict rules, planning trades out before entering them and taking only the best setups, will produce consistent results and a healthy mind set. Getting into the habit of winning consistently and taking the right trades is not easy but a process that will grow as you grow.

I hope this article has maybe made you ask yourself the question “do I trade the right sized candles or do I trade too much?” I know I myself fell foul to this in the beginning of my trading journey. My initial eagerness to be in the markets all the time clouded my judgement and got in the way of making consistent profits.




Author.
My name is Jeremy Poor, I am a professional Forex trader and my aim is to help aspiring traders to learn all about trading the Forex using Price Action  and where to look and hunt for the best trades. With lots Forex articles, videos and a dedicated  price action forum to look at, its a great place to learn how to become consistently profitable at trading the Forex.

Weekly Review 15/12/13

Hi traders, lots of pairs approaching some key levels. I have included the pairs I have on my radar, the highlighted levels will be where I will hunt for price action setups over the next week. The levels are all marked off the daily charts but I will go down the time frames to see if we get any juicy price action setups. The USD/SGD has formed a pin bar at a key level, I have marked a level below the pin bar and if price manages to break the low of the pb this would be where I'd expect price to reach before struggling.
Good hunting and remember to focus on taking price action setups that screams out "TRADE ME!!!"

Retracement Entries

A common thought process a lot of traders have when they first see a new price action setup form, is to immediately focus on getting the best entry point for that particular trade. This sounds perfectly understandably but at what cost?

 

What is a retracement entry

When a price action setup forms, for example a bullish pin bar, rather than place an entry order above the nose of the pin bar, orders can be set within the range of the pin bar. The retracement entry can be set using various methods, some use the Fibonacci retracement levels and place orders at the 61.8% fib. Alternatively, a key level visible within the bar can be used to place an entry.

Why retracement entries are so dangerous

We need to consider what price has to do for us to get entered into a trade, so when a trader places a retracement entry, for it to get filled, price has to move in the reverse direction to where you want it to go.

In my opinion, for any price action setup to be validated, I have to see price break the high, (if we are going long) or low (if we are going short) of the candle. This means we are saying to the market that price has to be going in the desired direction before we get entered into any trade.

 

Why would we want to get into a trade going the opposite direction?

The main reason traders use the retracement entry technique is because traders want to reduce their stop loss to increase the risk/reward for that particular trade. Sounds like a good idea, right?

Well, yes when it works out it feels great but in my opinion entering trades where the price action candle hasn’t even been validated is crazy!!

Getting too cute with the Forex markets is why traders get their butts kicked, time and time again.

Alternative strategy

A far better strategy if you are set on trying to reduce your stop loss, is to modify the stop loss placement instead. Placing orders to get filled once the price action setup is validated by price moving in the right direction is much safer.

 

So where do we put the stop loss?

Trading the Forex using price action is all about reading and interpreting the information printed on the charts. This is not going to be an in depth article discussing stop loss placement but I just want to highlight an example of how we can adjust the stop loss.

We trade only from key levels and the price action setup will therefore have a key level within its range because we only take trades that reject a key level.

We have the option then to use this key level to protect our stop loss.

This is not a set rule and the majority of the time I will place my stop loss on the opposite side of the price action candle range to that of the entry point.

Are they worth the risk?

On the whole, taking retracement entries is an extra risk not worth taking. Too many times have I seen price action setups form and then price continue past them without the setups even being validated. This is where the uninformed traders lose out.




Author.
My name is Jeremy Poor, I am a professional Forex trader and my aim is to help aspiring traders to learn all about trading the Forex using Price Action  and where to look and hunt for the best trades. With lots Forex articles, videos and a dedicated  price action forum to look at, its a great place to learn how to become consistently profitable at trading the Forex.

Hunting the nzd/jpy 4hr

Watching this highlighted area I mentioned a few days ago for bullish price action on the nzd/jpy 4hr.






Author.
My name is Jeremy Poor, I am a professional Forex trader and my aim is to help aspiring traders to learn all about trading the Forex using Price Action  and where to look and hunt for the best trades. With lots Forex articles, videos and a dedicated  price action forum to look at, its a great place to learn how to become consistently profitable at trading the Forex.

Cad/Jpy daily

The cad/jpy daily has been in a range for a while now.  This example is to show how key levels off the daily are the best way to go hunting for trades.
I dropped down to the 4hr charts and saw this bearish engulfing bar form, unfortunately it didn't close bearish enough for my liking and could have been bigger. So I passed the trade up.
What is important though is it shows how yes we can mark our levels but the price action has to also meet our criteria. If both aren't met we have to let the trade go.
You will see the market come to your key levels quite often and no price action form but it move in the direction you expected. This is just part of trading and feeling like you missed an opportunity is wrong because you have stuck to your rules and if they are not met, we have to step aside. Discipline is the key guys.
So here's the daily chart to show the importance of the level

And here is the 4hr chart with the same level as the daily

NZD/JPY 4hr

Have the nzd/jpy 4hr on my radar to hunt for a bullish price action setup.

Weekly Forex review 07/12/13

So after the Non farm payroll release lots of pairs have broken out past key levels and I will be looking for pullbacks to these levels and some large price action.
I will post all my pairs but the main hunting zones will be highlighted on the daily charts and will be where I will be hunting for trades setups, sometimes using lower time frames. Click on the charts to zoom in.

AUD/NZD potential trade next week

The aud/nzd is pulling back to a key level I have highlighted it will be an area I will be hunting for a large price action signal. Also although I haven't added the fibs retracement tool on the chart, it easy to see this hunting zone is around the 50%-61.8% fibs retrace.
This is one to watch, probably now for next week.

USD/JPY 6hr update

The bearish engulfing bar that formed on the usd/jpy 6hr charts was counter trend, going against the current momentum. However the size of the price action indicated to me that it had a good chance of pushing lower.
This is exactly what happened, I used the first trouble are to protect myself and amended my stop loss using my own stop loss buffer technique, the trade reverse and did  manage to push slightly higher than my stop loss and so took me out of the trade for a break even trade.
Although you can see price has pushed on lower again, I am happy to take this result. To ignore these fta's is too risky for my style of trading and fta's have protected me from trades that would in turn become losing trades.

USD/JPY 6hr short

Shorting this bearish engulfing bar on the USD/JPY 6hr.

NZD/CHF update

This is another example of how simple trading can be, I have taken a fair chunk of profit off now. Modified the stop loss to lock in some more profit and seeing if I can get a small runner to get a bit more profit from this trade.

NZD/CHF 6hr trade update

Here's a quick update on my NZD/CHF 6hr beeb trade. Hit my first trouble area and amended stop loss as per trade plan.

Silver broken key level

So silver has broken a key support level and I am now hunting the lower time frames for a short price action setup if we get a retest of that broken level.

So the audusd daily beeb was a great trade, very simple and i took full profit on this one.

The audchf daily beeb also produced a full profit trade. Very nice setups.