That is an excellent question. The stop on a Long term trade is designed to take you out of the trade if the basis of the trade is no longer valid. It also serves the dual purpose of protecting your trading account in the event of a sharp reversal in price during the initial phase of the trade. Note that I took two trades at the same time, eu and uchf, to reduce my risk through diversification and increase my profit potential. I only took them both because they were both well thought out trades and price action confirmed my entry. In the first hour of these uchf and eu trades, if the price had gone more than 30 pips against us, we would have manually exited as our entry plan would have been invalidated. In the first day if the trade moved sharply against us we would have manually exited, or if we are away from the computer the stop will take us out at a 150 pip retracement. Now it’s time to consider the stop loss management going forward into the trade.
One of the worst mistakes in long term trading though is to tighten our stops too quickly and get kicked out right at the maximum point of a routine retracement, essentially creating a large loss out of a large gain. So we have to balance out the need to lock in profits and protect our trading account with the need to not get kicked out of a trade right on the worst point of a routine retracement.
At this moment we are about 200 pips ahead in these combined trades with each trade about 100 pips ahead, eu a little more and uchf a little less, so the initial stop loss that was set at 150 pips for the 1st lot is now about 250 pips on average. Certainly if this trade moves against us by 250 pips, it has deviated from our belief about the future price movement and we should exit. But now we ask, what is the minimum distance price need to deviate before we would consider our belief about future price movement to be invalidated.
For uchf, the daily ATR is about 157 pips still. This along with some chart study tells us that a price drop of more than 160 pips in a day is unlikely in any particular day. It is likely however given a long enough period of time. Looking at the weekly ATR for uchf, it’s now at 246 pips, meaning it’s unlikely that we will see a retracement greater than 246 pips in any given week, though it likely in a period of enough weeks. Since our trade has already survived a day, but not yet a week, we are at the point where we should think of capturing some of the profit, or actually reducing the risk of the trade a little, but still avoiding the catastrophe of stopping out on a routine retracement. That would put a sensible stop somewhere between the 152 current daily ATR and the 246 pip weekly ATR. We have only been in the trade for 1 day, or 1/5th of a week, so a reasonable approximation is to move the stop 1/5th the distance between the two and to do so any day profit exceeds that amount each day of the first week of the trade, thereby reducing risk overall in the trade each day by an amount that will put us near the weekly ATR by the end of the week. Of course, if there isn’t enough profit in a day to move the stop without actually increasing risk of stopping out on a routine retracement, then we can’t move it, or we can’t move it that much. So, we never move a stop in a way that increases our risk in the trade, and their are two risks to balance out, getting taken out at the worst possible moment with a routine retracement, and needing to taken out of the trade legitimately because of some fundamental or technical shift in the basis of the trade.
So in uchf, the stop should be increased (246-152)/5 = 19 pips each day this week, if and only if we have made that much profit in the last day. Our profit is
at the moment 59 pips, so we have enough profit to increase our stop width, essentially reducing our risk of being stopped out by a routine retracement, while also capturing some of those pips and reducing the risk that a change in trade basis will cause us to lose all our initial stop loss. I like round numbers in managing stops and I had set my initial stop at 150 pips, so I will increase it by about 20 pips to about 170 pips now. This essentially moves my stop up about
40 pips from where I entered yesterday. Note that the cardinal rule applies that we never move a stop against the direction of our trade. Also, we only adjust a stop once a day, preferably about the same time each day, to prevent overtrading.
Since the close of the London session is minutes away, and volatility usually drops after the London session is closed, I will wait until that session is closed to adjust my stop and I’ll do it every day at the same time, rounding things a bit and moving it 20 pips a day any day I make 20 pips or more in profit. If and when we get a full week in this trade, we will follow the same process moving once a week to the monthly ATR.
These are big numbers we are dealing with. You don’t really have to wait 200 pips to exit a trade if it moves against you. You can actually exit anytime for any reason. But if you chose to exit early, you should carefully evaluate the impact and results of that decision. You’ll find that 4 out of 5 times you should have stayed in the trade, and only one in 5 it saved you a little stop. Still, if you are sure the basis for your trade has become invalid, as in the release of some unexpected and drastic news or a major change in politics like a war breaks out, by all means exit a trade that is moving badly against you. Of course, at least 50% of the time the trade will actually move faster and further in your direction. This can actually serve to offset some risk in other investments like stocks, bonds or commodities.
Now to move my uchf stop up about 40 pips and do the same calc and move the eu stop.
Let me know if you have any questions about any of this.
Postscript Note: The eu stop should be increased by 25 pips a day in this calculation. We don’t move stops of later lots until the 1st lot catches up with them, then we move them all in unison.
