Multi-Time Frame Trend Trading

[gasanvill]

I will now begin to present the much promised stop loss analysis tool. The purpose of this tool is to let you know if your stop loss is too large or too small for your trading method. If your stop loss is too large or small for your method, you have two choices, change your stop loss, or change your trading method. I’ll begin with an introduction and then proceed to calculations charts and graphs. You can do all these calculations and graphing with pencil and paper, but it’s much easier with a spread sheet program like Excel. I won’t be able to answer Excel questions here, but there is lots of free help and tutorials on line. So let’s get started.

The first step will be a very rough look at stop loss performance. We will then drill down on this and get more precise as we go along. If you’ve been keeping trading logs for a long time, you should have lots of data sets for this. If you haven’t collected the data, now is the time to start. For this first step, you will only need log data on stop loss settings and pips won or lost for each trade which should be available in just about any trading platform’s trading logs. Before we get into the heavy lifting of charts and graphs and calculations, let’s take a moment to look at what a stop loss is for, and more importantly what it isn’t for.

A stop loss should be used to protect your trading capital, and once you have a good profit in a trade, to protect your profits. That should be its only use. In most cases you don’t want to use a stop to take profits because the stop trips when profits are at a minimum. You want to take profits when they are at a maximum, or as close to a maximum as you can get. In most cases a stop is useless for that purpose. So in most cases, if you don’t have a profit in a trade yet, the stop loss prevents price from moving sharply against you and making your loss even worse. If you have a good profit, the stop prevents a sharp move from taking all your profits away. A stop loss should be an emergency measure to protect your account balance. In the best trading, you will almost NEVER hit a stop. In the best trading, the only time you hit a stop is when price suddenly and unexpectedly moves sharply against your position. If that happens more than once a week in day trading, you aren’t trading right. Let me explain this more, because it’s important.

If a trade is moving against you on entry, you should recognize it as a bad entry and early exit to prevent more loss. You can always re-enter later if you think you have a better entry point and the basis for the trade was solid. The cost of that is only a few pips in spread and you save yourself from the much larger possible loss of waiting until the stop is hit. If you have a small profit in a trade, and price turns against you, you should early exit with a few pips profit or as near to break even as you can. Letting a small win turn into a large stop out loss is not good trading. If you have a large win, you should let your profits run as long as possible and exit to take profits as near a profit maximum as possible. You should never sit by and watch that good profit waste away until it hits your stop loss. That is not good trading.

If you have read Tymen’s good example of comparing the movements of the ocean to price movements, you can see what I mean. There is a large tide movement that relates to a long term price movement up or down, seen on the monthly and weekly charts. That long term movement can be used for position or swing trading. There are big waves that roll in and out that can be used for day trading, as seen on the daily, 4H and 1H charts, and there are little wavelets that we ignore except for optimizing entry and exit points. Totally ignoring the little wavelets doesn’t make that much difference, but I always use them, as seen on the 1M, 5M and 15M charts, to optimize my entries and exits to squeeze that extra few pips out of every trade. Every pip counts.

If you are day trading, you’ll do better over the long haul if you trade in the direction of the longer term trend, or the tide. Say you are trading up, you want to enter a trade when long term direction is up, or tide is rising, and you want to enter, or put on more lots, when the big wave is at a minimum or in a valley between waves, and to optimize entry enter when the little wavelets are also at a minimum or in a little valley or trough. For day trading, it’s the big waves that count the most. The tide doesn’t have that much effect, but it’s slightly better to trade with it than against it. The little wavelets are the scalpers’ specialty and they can’t make a nice big fat profit for day traders over the long haul, though they can be used for optimization as stated above.

So you’ll want to take profits when the big wave is at its maximum, or as close to its maximum as possible. You also want to take profit when the little wavelet on top of the big wave is also at or near its maximum to optimize. Since a stop loss almost always executes when the big wave is nearer its minimum, it’s worse than useless for that purpose. You’ll need to use other methods to maximize taking profits and we can discuss those separately.

There are lots of things that can be done to reduce stop out losses. Avoiding trading big known news events, obtaining better entries, exiting earlier before the stop loss is hit and other things work well. We can discuss those separately, but for the moment take this challenge. Practice trading one full week without ever hitting a stop loss by making better entries, early exiting and avoiding major news events, NOT by making the stop loss larger. Of course, moving your stop against the direction of your trade to stay in a losing trade is strictly forbidden in my trading system. Making your stop loss larger when you are losing will just cause you to lose more. Trading a full week without hitting a single stop loss AND without making your stop loss larger than you normally do is a huge exercise in trading discipline. If you haven’t developed that discipline yet, now is the time to start. So even if you early exit a bad trade 1 pip before it hits your normal stop loss point, you have been successful in avoiding a stop out loss. As you practice this, you can reduce losses to near zero and what’s left is Break Evens that pay the spread, small wins and huge wins. We like those.

So to conclude this introduction, stop out losses are caused by three things, bad entries, trading big news events where price moves sharply and moving the stop loss to quickly toward the price trying to lock in profits too early, which is really just greed. You can’t always avoid unexpected news, but you can avoid the big expected news events, and most of the time, even on unexpected news, you can still exit before your stop loss is hit, if you are nimble. You’ll make some bad entries, everyone does, but if you learn to simply recognize a bad entry as one that goes against you right after entry, and admit to yourself you have made a bad entry, you can exit those early and almost never hit a bad entry stop loss. Moving the stop loss too soon and too close to the price action is something we will look at in more detail. That’s where the math, charting and graphing will help. We’ll get in to that next, but really, if you think about, understand, and practice the principals discussed above, you’ll achieve 80% of what I have to present without a single calculation or graph.

Any questions?

Graviton,
I have a question: how many pips we have to let the trade go against us? Lets say i have a 30 pips SL. If tha trade goes against me 15 pips i close it?

Thanks again!

[didilut]

In the end though, hardly anyone will reach 100% good entries. But after many weeks of study and improvement you will become an expert in recognizing a bad entry. So what do you do about it when you find yourself in one? The best way to deal with a bad entry is to early exit. Never wait until price creeps up to your stop loss point and stops you out. That’s not what your stop loss is for. Your stop loss is stupid. It’s only function is to take you out of a trade in case of a sudden and unexpected spike against you. Once you’ve learned to recognize bad entries, and you have developed the trading discipline to early exit from them, you need never hit a stop loss again from a bad entry. You should set a goal for yourself to never hit a stop loss because of a bad entry. It can be achieved if you practice.

Graviton, I realize that we are fortunate to have an experienced big man on this thread, which opens the eyes of the reactions I had, and that helps me to question myself, and progress.
Thank you, and thank you for putting us in great slaps his head:eek: to wake us and make us aware of our weaknesses, but also give us the means to overcome them and move forward, because JFK was right, and you too!
Thank you, THANKS!
Regards, Didier.

[Graviton]

Graviton,
I have a question: how many pips we have to let the trade go against us? Lets say i have a 30 pips SL. If tha trade goes against me 15 pips i close it?

Thanks again!

Good question! I’ll answer this in detail in my next post. Keep asking good questions and we’ll all get to our goal together

[Graviton]

Graviton, I realize that we are fortunate to have an experienced big man on this thread, which opens the eyes of the reactions I had, and that helps me to question myself, and progress.
Thank you, and thank you for putting us in great slaps his head:eek: to wake us and make us aware of our weaknesses, but also give us the means to overcome them and move forward, because JFK was right, and you too!
Thank you, THANKS!
Regards, Didier.

Thanks Didler. We are about 1/3rd of the way through this difficult task. I hope to finish in the next day. Most of this I’ve practiced for decades but never written down. I wasn’t even sure it could be written down until I tried. Good questions help me to work through all this, so if you have any questions as we go, please ask.

[Graviton]

Let’s review and summarize a bit before moving forward. I apologize in advance to any experienced traders reading this and who are offended by my blunt manor. I don’t mean to be talking down to anyone. I also apologize in advance for this being so long and complicated. Believe me, I’m doing the very best I can with this difficult subject. I just don’t know how to do this quicker or better. So on we go.

A stop loss is a very quick but very stupid tool. It has only one legitimate purpose, to take you out of a trade when an unexpected spike against you exposes your capital to risk and that spike is too quick for you to exit manually. You should not let something this stupid trade your account for you if you can help it. Instead, use the greatest pattern recognition engine known to trade your account, your brain.

Stop out losses come in four types. Sudden spikes, bad entries, good trades turned bad and moving the stop too fast and too close to normal price action volatility. You need to start logging every trade and keep data on which of the four types each of your stop out losses fall into. Do that now as that information will be critically important going forward.

Sudden spikes come in two types, expected and unexpected. We can avoid all expected sudden spikes by being out of the market when we expect they will occur. We can minimize the losses from unexpected sudden spikes by trading with minimum stop loss settings. In most cases, we really do have time to exit a move against our trade before the stop loss is actually hit. We must analyze those cases and constantly improve at exiting early to minimize those impacts on our trading results. We also need to define what a minimum stop loss for a particular trading method is. We will need to create three very good tools to do this job. One tool is to measure our effectiveness at avoiding expected spikes altogether by simply counting how many we get hit with per week or per month. Our goal is to make that number zero. A second tool is to measure our effectiveness at exiting early from spikes by measuring our losses from staying in these spike trades. Our goal is to reduce that number to the absolute minimum. A third tool is to determine what a minimum stop is for a particular trade. That will be a most important tool, but it will get much simpler to create after we carefully examine each category of stop out losses.

The second type of stop out loss is that caused from bad entries. If we reduce our bad entries in the first place, we can reduce these losses. If we can learn to recognize those bad entries that remain early enough, we can exit early to reduce those stop out losses even further. Our goal is to have zero stop out losses due to bad entries. We will never get all the way to zero, but we can make great improvements in this area, yielding only a few small losses and no large ones at all. If we gather information about what makes good entries good and bad entries bad, we can find patterns in that data and work to increase the percent of good entries and reduce the percent of bad entries. We will need two tools for this task. One simply measures the percent of good entries vs. bad entries and records the reasons for each trade so we can recognize patterns in each and work to reduce bad entries. The second tool will measure our effectiveness at recognizing bad entries early by measuring the average pips lost on bad entries.

Now we will soldier on. A third reason for stop out losses is good trades turned bad. This is the case where we have a good entry that goes 10 or more pips in our favor. Maybe it goes 60 or 80 pips in our favor, but then it turns around and gives all those pips back and takes away a big fat stop loss as well. These are heartbreakers, but don’t get mad, don’t get even, get better than even. Looking back on these trades it’s always clear. You had the chance after a good trade 12 pips up went bad to exit a few pips ahead, but you didn’t. You had the chance after the trade was up 60 pips to exit with 40 pips profit, but you didn’t. Why? It’s simple human nature.

In the human psyche, hope springs eternal. Hope is probably the only reason we don’t all jump out the window of a tall building on any given day of the week. Hope can be productive in the broad sense of trading, in that you hope that with study and practice to become a better trader over time, and that gives you the strength to soldier on. But hope has no place in any one given trade. The market doesn’t only not care about your hope; it will actually use your hope against you. Any time a trade has moved well in your favor, there are millions of traders just like you that are hoping it will continue in their favor. But there are a few large traders that know the market never moves in straight lines. As soon as they see the market retracing a bit, they trade the retracement. They are hoping also, hoping you are going to stay in the trade long enough so that they can take all your profits and your stop loss too. Most of the time they are right and most of the time you give back all your profit and a nice big fat stop loss too. Increasing your stop loss doesn’t help. In the end that just gives back more to those who would prey on your hope.

Abandon all hope ye who enter here. Instead of hoping a trade will continue, or come back after it has turned against you, fight for every pip you can pull out of it. If a trade goes 12 pips in your favor and turns, exit with two pips profit and live to trade another day. It doesn’t feel good. It’s not satisfying. But that’s trading. As often as not, the thing that makes you feel good in trading is wrong; and something that is about as satisfying as having a boil lanced is right. Trading on hope and feelings is no better than flipping a coin and often is worse.

Take your 2 pips and take a break. Don’t obsess over the 40% of the time that the trade turns back to go on to make 120 pips. Simply ignore that twist of fate and go right back to work looking for another good entry on this pair or another. You miss 10,000 good trades every day in some market somewhere. You just can’t trade with that burden on your shoulders. You must free yourself from it. You take your small pip profit, even if it’s only one pip, and congratulate yourself for having done the difficult but right thing, then move right on to the next trade with no burden or excess baggage. Maybe fighting for a couple pips just doesn’t seem worth the effort to you. If you don’t have the will to fight for 1 or two pips, you won’t have the guts to fight for 40 when you are 60 ahead or 200 when you are three hundred ahead. This is a test of your will. You must win this test to become a trader.

Start by setting some rules for yourself and enforce them yourself. Don’t depend on a stupid stop loss to take your profit out of a trade. A stop loss always takes you out of a trade with a minimum profit, not the maximum profit you seek. You need to be in charge of when you take profit, not a stupid but quick stop loss. I’ve already given you a great tool for measuring your profit taking efficiency in a previous post. Use the PE=AP/MPA tool to measure your effectiveness at taking the maximum profit out of a trade. Until you get very good at it, set up some rules to follow and find the discipline within yourself to follow them. You can make them simple to start and improve them as you go along. If you just set a rule to take 1 pip of profit for any trade that goes more than 10 pips in your favor, you will never take a stop out loss for any trade that goes more than 10 pips in your favor for the rest of your trading career. For many, that one simple rule will make a huge difference in trading results. Sure you will early exit a lot of trades, but you will early exit with no loss instead of losing one big fat stop loss after another. Set another rule, if you get 30 pips ahead, you will early exit with 20 pips profit minimum. Set another rule, if you are 60 pips ahead you will exit with 40 pips minimum, and so on. Measure the effectiveness for your rules using the tool I’ve given you. Different rules will be required for different trading methods with different time frames on different pairs. I can’t give you the rules that are perfect for you. I can only give you tools to discover those rules for yourself. If you like, above a certain trigger, say above 30 pips profit, you can use PSAR to take your profit out on a peak rather than a valley. You must be in control of your trades, not me, and not your stop loss.

The conclusion here is you need to trade with your brain and not where a stupid stop loss takes you out of the trade. You’ll need a tool that that categorizes which of the four categories your stop out losses are coming from and one that counts how many times you violate your own take profit rules. If you create a set of take profit rules and follow them and continuously work to improve them, you can turn this source of stop out losses into a source of profits and completely eliminate this category from your trading. So you need four tools for this task. The PE=AP/MPA tool evaluates your rules efficiency at taking maximum profit and allows you to continuously improve your rules in an objective manor. You need to categorize your stop out losses to determine how many fall into the good trade turned bad category. You need to count the times you violate you’re your own take profit rules and reduce those violations to zero. Your goal in the end is to turn this category of stop out losses into a source of profit. That is really fairly easily done.

We only have one more category of stop out losses to consider, those caused by moving the stop loss too close to the price action volatility to soon. I’ll consider that in my next post and then we’ll summarize all these four categories and stuff our tool kits with all the tools needed to repair any broken notions of how to use stop losses.

[NForex]

Let’s review…

Thanks for sharing your experiences & knowledge Gravitation!

I could learn a lot from your last posts!

Looks like for being successful at forex its not only about what you win but what you [B]dont loose[/B].

Nah im not sure how to describe what im thinking. Sry

Anyway thanks for sharing!!

[Graviton]

Thanks for sharing your experiences & knowledge Gravitation!

I could learn a lot from your last posts!

Looks like for being successful at forex its not only about what you win but what you [B]dont loose[/B].

Nah im not sure how to describe what im thinking. Sry

Anyway thanks for sharing!!

Oh I agree completely. For most traders the problem isn’t they don’t win enough, the problem is they lose way too much. I lost tons in the beginning before that finally sunk into my thick skull. I kept thinking that if I won more, I would be successful at trading. The problem was that over the long run I always lost more than I won, no matter how much I won. I finally realized that the only way I would ever be successful at trading was to learn first how not to lose. I then set a goal for myself to not have any losing weeks. Perhaps I’m just a slow learner, but it took years for me to learn how to trade without having losing weeks. I found it to be many orders of magnitude more difficult than just winning. Perhaps some lucky traders can be successful without ever learning how to not lose, but that never worked for me. It took me two years to make 4 weeks in a row positive at the end of each week, and three years before I had 8 non-losing weeks in a row.

Even now after over two decades, I still fight every single week to end the week ahead. I’ve had many low percentage wins this year at the end of a week and that doesn’t bother me at all, but I lost a week in March despite my very best efforts to make this year a year without a losing week. The good news is, if you can learn first how to trade without losing, winning becomes terribly easy by comparison. Profits just seem to fall in your lap week after week. It’s weird, but I believe it’s true. The best way to learn to win at Forex is to learn how not to lose. Thanks for your comments

[FX1]

Thanks for sharing your experiences & knowledge Gravitation!

I could learn a lot from your last posts!

Looks like for being successful at forex its not only about what you win but what you [B]dont loose[/B].

Nah im not sure how to describe what im thinking. Sry

Anyway thanks for sharing!!

Hi NForex,

You have found the key to success in the Forex game. Most newbies only count their wins and forget about the losers. I record every loss and analyze why I made the trade in the first place and why I lost. Everyone of my losers can be explained very simply. I didn’t follow the plan and made a stupid trade.

The problem with using a stop loss is that they are set with little or no thought and to a newbie trader this means a plan for loss. They trade with no real plan to make any pips just a hope and a prayer. The only real planning is the stop loss which gives a false sense of security.

I find it quite ironic that these same traders wouldn’t go a mile down the road without knowing where their final destination is going to be as the price of gasoline is just too high to waste it. When it comes to trading the forex they jump in without looking to see if the pool has any water in it.:eek:

Losing trades are a traders worst enemy and as they say keep your friends close and your enemies closer.

FX1

[FX1]

Oh I agree completely. For most traders the problem isn’t they don’t win enough, the problem is they lose way too much. I lost tons in the beginning before that finally sunk into my thick skull. I kept thinking that if I won more, I would be successful at trading. The problem was that over the long run I always lost more than I won, no matter how much I won. I finally realized that the only way I would ever be successful at trading was to learn first how not to lose. I then set a goal for myself to not have any losing weeks. Perhaps I’m just a slow learner, but it took years for me to learn how to trade without having losing weeks. I found it to be many orders of magnitude more difficult than just winning. Perhaps some lucky traders can be successful without ever learning how to not lose, but that never worked for me. It took me two years to make 4 weeks in a row positive at the end of each week, and three years before I had 8 non-losing weeks in a row.

Even now after over two decades, I still fight every single week to end the week ahead. I’ve had many low percentage wins this year at the end of a week and that doesn’t bother me at all, but I lost a week in March despite my very best efforts to make this year a year without a losing week. The good news is, if you can learn first how to trade without losing, winning becomes terribly easy by comparison. Profits just seem to fall in your lap week after week. It’s weird, but I believe it’s true. The best way to learn to win at Forex is to learn how not to lose. Thanks for your comments

Hello Graviton,

I have only read a few of your posts but it is quite evident you didn’t just get off the banana boat. I’m not exactly new to this forex trading either but have approached it from the begining as I do anything else and that is with extreme caution. I have read for months and months now and have traded and won and also have traded and lost. I’m now ready to trade for a living but will go at it at a slow and steady pace.

It seems to me that trading is much like anything else in this world, you get rewarded for whatever you are willing to put into it in time and effort. There seems to be much talk of trend trading on many threads but the entries and exits seem to be very weak.

You seem to be more detailed in your trades moving down to the lower time frames to place your trades which seems like the only smart thing to do. I can’t understand anybody trading the Daily and only making trades on the Daily.

I have been a little disappointed in most threads I’ve read as there are very few well defined entries or exits. Most are using very simple moving average crosses which work some of the time but fail a lot because of being to late and way too often.

I really need to read more of this thread before I type anymore as I’m not sure how you trade but after reading a half dozen of your posts you show more knowledge then any thread I’ve read here and a whole lot less confusing. Thanks for your posts and I will look forward to trading ideas with you.

Thanks again,

FX1

[NForex]

Hi [B]Gravitation [/B]and [B]FX1[/B]

I just notice how improtant it really is.
I suddenly completely think different about a StopLoss.

Yesterday and today i could cut two loosing trades before the stoploss was hit. A few minutes later those trades would have actually been stopped out leaving me with a lot of negative pips. Now it actually feels like i made a winning trade

By cutting these loosers my trading week is still a winning week so far.

[B]What i failed on today was protecting my profits.[/B]

• I was in a good trade and put my Stoploss to breakeven.
• Suddenly i felt and saw the trade moving against me.
• I saw my profits vanishing.

I remember sitting there and even saying “[I]This looks bad. Get the f*** out and take your profits.[/I]” to myself.
But i was frozen and just hoping.
A few minutes later i was stopped out at break even.

Well at least i was clever enough to notice that this was an excellent example for “protect your profits”.

[Graviton]

Whew! This is turning out to be one of those epic journeys. I hope when we get to the end of this long road you agree the trip was worth the effort. We are now about half way home and with luck we’ll be there by tomorrow. I commend anyone who has made it this far and soon I hope to pass out your merit badges in the form of a stop loss tool kit. I’ll probably wind up coming back later and throwing in some more on taking profits, as these two subjects are so closely related. But for the moment, let’s only take on one monumental task at a time.

The last of our four categories of stop out losses is one that we do to ourselves, moving a stop too close to normal price action volatility. Since we are NEVER allowed to move a stop against the direction of our trade, if we move a stop, it will be toward the danger zone of normal price action volatility. This usually happens when a trade is well ahead and we want to move our stop to break even or lock in profits by moving the stop loss closer to the price. Of course we will want to adjust our stop loss to keep it at optimum, but that optimum may have very little to do with how much profit we’ve made. Once again, the problem in using a stop loss to exit a profitable trade is that isn’t what the stop loss is for. A stop loss will almost always take you out of a trade at the profit minimum rather than the maximum or even a good place in between. The stop is only good for one thing and that is to protect your capital from sudden spikes in price that you can’t exit out of earlier. So it’s clear that to avoid this type of normal volatility stop out loss, we need a better tool to determine where an optimum stop should be set in combination with the discipline to exit bad trades as soon as we can and well before they hit that stop.

Since every trader trades a little differently and some trade many different pairs in many different time frames, there isn’t one stop loss setting that’s good for everyone in every situation. What we can do though is work to create a tool that will measure the efficiency of our stop loss settings over time. Then for a particular trading method we can say if that stop loss is too large or too small and adjust it to optimum. If the stop loss is too small, the trade will be stopped out too quickly due to normal price action volatility. If the stop loss is too large, we will suffer large losses on the occasional sudden unexpected spike against our trade. This trade off is ignored by some traders who just think they can trade with very large stops and never get stopped out. It works until they are hit with a quick spike and then lose all their profits back and then some.

The spike out risk number must be balanced against being stopped out by having a stop too close to the normal volatility of the price action. Since the only legitimate purpose of a stop is to protect our trading capital from sudden unexpected spikes against a trade, the further away from that normal price action volatility the less pips that will be lost to the normal price action volatility category of stop out losses. But the larger stop also means when we are hit with a spike we will take a larger loss. Again, we aren’t trying to increase the stop to keep us in a bad trade longer. We should exit those long before they hit a stop. We are trying optimize the stop to leave us in a good trade, while still protecting us against large spikes that could put our capital at risk.

It’s clear our optimum stop must take normal price action volatility into consideration, since that’s what we want to stay away from. Both ATR and PSAR take the normal price action volatility into consideration. The PSAR is a good starting point but it has some problems. In a sideways market, the PSAR can swap back and forth between buy and sell signals and become unreliable. ATR on the other hand is an objective measure of volatility for any situation and since it’s an absolute value number (always positive) it doesn’t matter whether you are long or short, the ATR always is an objective measure of volatility at that point in time. If we start using ATR as our stop setting, we can adjust our stops larger or smaller from that starting point depending on our results. These adjustments will take some time to arrive at manually, but if you can run a simulator you can get there fairly fast. I have found through experience though that 1 X ATR is usually a larger stop than needed with good entries on longer timeframes and it is smaller than needed on shorter timeframes.

So following our theory that a stop should protect us from exposing our capital to sudden unexpected spikes, and yet not get taken out by normal price action volatility, we can measure the pips lost by a stop out due to normal price action volatility and how often it is taken out by sudden spikes and balance these off one another.

Since the price action volatility loss really loses some or all of our potential profit we can’t just count the negative pips or the stop loss as its total loss. We really need to take the average Profit Efficiency that we calculated earlier for these types of trades and multiply that by the maximum profit that was available at any time in this trade to get an estimate of what the potential lost profit was. If we add that estimated lost profit to our stop out loss amount it gives the total damage caused by running the stop too close and being taken out by price volatility. That’s the number that needs to be compared to the spike out risk to arrive at a proper stop amount. Of course, there’s lost estimated profit due to spike outs also. So we have the option of ignoring the lost estimated profit on both sides of the equation, or considering it on both sides to be more precise. Since it adds a lot of complication to the calculation, for the moment we’ll ignore the lost profit on both sides and just consider the stop out losses.

So if our stop was 40 pips and was taken out by sudden spikes 4 times in a month for a loss of 160 pips, but we were only taken out by price volatility from moving our stop closer to price twice in a month for a 80 pip loss, it would make sense to tighten up our stop more until these numbers are closer, so stop could be reset, perhaps from 1 X ATR to 0.8 X ATR. When the spike out loss is equal to the normal price action volatility stop out loss, we can’t adjust either way without losing more on one side or the other. At that point we can say our stop loss is set at optimum.

Or is it? Remember the Tymen’s ocean example? The main tide represents the very long term monthly and weekly charts, the big waves represents the daily, 4H and 1H charts and the little wavelets represents the 1M, 5M and 15M charts? If we’re going to jump into the boiling ocean of Forex, wouldn’t it make sense to know where in the ocean we are? This is the time to do a sanity check of our stop placement. If ATR should give us a good stop out of the way of the wave tops that would take us out of the trade, we can verify that calculation simply by looking at the charts of the timeframe we are trading. Day traders are trading the big waves, so the stop should put us above the tops of the big waves so we can stay in the trades long enough to make a profit and not be taken out of the trade at a profit minimum. But the question has been asked, which chart should we refer to, the 1H or the 4H, and how far back should we look to see if our stop is above the wave tops for a short trade (or below the bottoms for a long trade)?

I don’t know of a one size fits all answer to this question. If someone else has a suggestion I’d be happy to hear it. It’s partly a question of time. The longer we intend to stay in a trade, the more likely we are to be taken out by a peak wave top. I look at my stop placement relative to my entry and what I believe will happen in the trade. Usually I am entering a trade on a break of a retracement trend line or a valid CBL or even better a combination of both signals. When I combine a CBL and the break of a retracement trend line I get a very high win/loss ratio and a very good reward to risk ratio as well. But that’s just my personal method of trading. I like to enter a trade near the middle of the London morning session after some daily direction has formed and stay in that same trade all day, or until the market has definitely turned. All the quick in and outs just don’t seem to work for me. So I’ll want my stop at least above the last lower high for a short trade on the 1H chart, and at most above the last lower high on the 4H chart. That’s consistent with the rule of thumb that a trade should last about 4 to 6 times as long as the home chart time frame. It’s also consistent with Tymen’s rule of placing the stop just above the extreme candle, so if I’m trading a down CBL on the 1H chart, the previous lower high will also be just above the extreme candle. That’s just the way a CBL always works.

So if the ATR tells me my stop should be about 38 pips, and a stop above the last lower high runs 30 to 45 pips, I’d consider that a reasonable sanity check and place the stop just above the last lower high. But if the ATR is 38 and just above the last lower high is 80 pips, that is just too much disagreement. I’ll either wait until another lower high is formed that may be in better agreement or look for another chart to trade or another pair to trade. Often if I just can’t place a stop on the EU 1H that makes sense, I can place one on the 30M chart, knowing that trade may last only a half day, or I may find that EJ has essentially the same chart formation and I can place the stop there. In any case I don’t want to place a stop that is double the ATR as that will produce too low a reward to risk ratio to justify taking the trade. The bottom line here is some trades just aren’t worth taking. The risk is just too high even though everything else looks good. If you run the simulations and delete any trade that has a stop greater than say 1.5 ATR on the chart where the CBL appears, I believe you will greatly increase your reward to risk ratio without affecting your win loss ratio at all. Tightening that constraint further improves reward to risk, but eventually reduces the number of trades available to not be productive in pips won. That has been my experience and I’d be interested in hearing from the simulation experts to see if their work confirms this.

That concludes the philosophy section of setting and using stops. I’d be interested in hearing feedback from any traders including questions, comments, corrections or disagreements. As I’ve said many times, every trader trades differently and I know of no one method that fits everyone, but a good tool that objectively evaluates the efficiency of a traders’ method should apply to any trader or any method. I’ve given some hints on tools we could use for that purpose as we went through the philosophy section. The next section will concentrate on tools that we use going forward to optimize our trading including setting and moving stops.

[Graviton]

Hello Graviton,

I have only read a few of your posts but it is quite evident you didn’t just get off the banana boat. I’m not exactly new to this forex trading either but have approached it from the begining as I do anything else and that is with extreme caution. I have read for months and months now and have traded and won and also have traded and lost. I’m now ready to trade for a living but will go at it at a slow and steady pace.

It seems to me that trading is much like anything else in this world, you get rewarded for whatever you are willing to put into it in time and effort. There seems to be much talk of trend trading on many threads but the entries and exits seem to be very weak.

You seem to be more detailed in your trades moving down to the lower time frames to place your trades which seems like the only smart thing to do. I can’t understand anybody trading the Daily and only making trades on the Daily.

I have been a little disappointed in most threads I’ve read as there are very few well defined entries or exits. Most are using very simple moving average crosses which work some of the time but fail a lot because of being to late and way too often.

I really need to read more of this thread before I type anymore as I’m not sure how you trade but after reading a half dozen of your posts you show more knowledge then any thread I’ve read here and a whole lot less confusing. Thanks for your posts and I will look forward to trading ideas with you.

Thanks again,

FX1

Thanks for the feedback and welcome aboard FX1. This is a joint effort among many interested in trend trading and we’ve probably just scratched the surface of the topic so far. My trading method suits me, but others have methods that work well for them and I wouldn’t advise changing a winning method. Setting and moving stop loss points is something we all share though, so I thought opening a discussion on that point would be beneficial to all. I’d appreciate any feedback you have. Happy trading!

[Graviton]

Hi [B]Gravitation [/B]and [B]FX1[/B]

I just notice how improtant it really is.
I suddenly completely think different about a StopLoss.

Yesterday and today i could cut two loosing trades before the stoploss was hit. A few minutes later those trades would have actually been stopped out leaving me with a lot of negative pips. Now it actually feels like i made a winning trade

By cutting these loosers my trading week is still a winning week so far.

[B]What i failed on today was protecting my profits.[/B]

• I was in a good trade and put my Stoploss to breakeven.
• Suddenly i felt and saw the trade moving against me.
• I saw my profits vanishing.

I remember sitting there and even saying “[I]This looks bad. Get the f*** out and take your profits.[/I]” to myself.
But i was frozen and just hoping.
A few minutes later i was stopped out at break even.

Well at least i was clever enough to notice that this was an excellent example for “protect your profits”.

Yep, been there more times than I care to admit. Bite the bullet and set some take profit rules. Don’t depend on a stop loss to take profits. You must do that yourself, preferably on the peak of a profit point. Don’t try to pick tops and bottoms, that never works. Just take profits on any peak according to your rules. Taking out profits on any peak, large or small is always better than giving them all back. An if another big run occurs, you can always re-enter for just a few pips. Essentially, you are risking a big fat profit just to save a few pips spread. That’s a really bad risk to reward ratio. Sure there are times you will exit a trade with a nice profit and it will turn around and you could have made another 50 or 100 pips, there will always be those times. But you can’t win if you don’t take profit. Try using the PE profit efficiency tool to evaluate your efficiency at taking profits and see if that helps.

[gasanvill]

Hi [B]Gravitation [/B]and [B]FX1[/B]

I just notice how improtant it really is.
I suddenly completely think different about a StopLoss.

Yesterday and today i could cut two loosing trades before the stoploss was hit. A few minutes later those trades would have actually been stopped out leaving me with a lot of negative pips. Now it actually feels like i made a winning trade

By cutting these loosers my trading week is still a winning week so far.

[B]What i failed on today was protecting my profits.[/B]

• I was in a good trade and put my Stoploss to breakeven.
• Suddenly i felt and saw the trade moving against me.
• I saw my profits vanishing.

I remember sitting there and even saying “[I]This looks bad. Get the f*** out and take your profits.[/I]” to myself.
But i was frozen and just hoping.
A few minutes later i was stopped out at break even.

Well at least i was clever enough to notice that this was an excellent example for “protect your profits”.

I did the same yesterday, and closed a couple of trades before my SL was hit!

The thing is that losing trades dont hurt so much when you know how to maximize your winning trades. This is the first time in that i´m positive in the week, after a lot of time and effort!!

[gasanvill]

Whew! This is turning out to be one of those epic journeys. I hope when we get to the end of this long road you agree the trip was worth the effort. We are now about half way home and with luck we’ll be there by tomorrow. I commend anyone who has made it this far and soon I hope to pass out your merit badges in the form of a stop loss tool kit. I’ll probably wind up coming back later and throwing in some more on taking profits, as these two subjects are so closely related. But for the moment, let’s only take on one monumental task at a time.

The last of our four categories of stop out losses is one that we do to ourselves, moving a stop too close to normal price action volatility. Since we are NEVER allowed to move a stop against the direction of our trade, if we move a stop, it will be toward the danger zone of normal price action volatility. This usually happens when a trade is well ahead and we want to move our stop to break even or lock in profits by moving the stop loss closer to the price. Of course we will want to adjust our stop loss to keep it at optimum, but that optimum may have very little to do with how much profit we’ve made. Once again, the problem in using a stop loss to exit a profitable trade is that isn’t what the stop loss is for. A stop loss will almost always take you out of a trade at the profit minimum rather than the maximum or even a good place in between. The stop is only good for one thing and that is to protect your capital from sudden spikes in price that you can’t exit out of earlier. So it’s clear that to avoid this type of normal volatility stop out loss, we need a better tool to determine where an optimum stop should be set in combination with the discipline to exit bad trades as soon as we can and well before they hit that stop.

Since every trader trades a little differently and some trade many different pairs in many different time frames, there isn’t one stop loss setting that’s good for everyone in every situation. What we can do though is work to create a tool that will measure the efficiency of our stop loss settings over time. Then for a particular trading method we can say if that stop loss is too large or too small and adjust it to optimum. If the stop loss is too small, the trade will be stopped out too quickly due to normal price action volatility. If the stop loss is too large, we will suffer large losses on the occasional sudden unexpected spike against our trade. This trade off is ignored by some traders who just think they can trade with very large stops and never get stopped out. It works until they are hit with a quick spike and then lose all their profits back and then some.

The spike out risk number must be balanced against being stopped out by having a stop too close to the normal volatility of the price action. Since the only legitimate purpose of a stop is to protect our trading capital from sudden unexpected spikes against a trade, the further away from that normal price action volatility the less pips that will be lost to the normal price action volatility category of stop out losses. But the larger stop also means when we are hit with a spike we will take a larger loss. Again, we aren’t trying to increase the stop to keep us in a bad trade longer. We should exit those long before they hit a stop. We are trying optimize the stop to leave us in a good trade, while still protecting us against large spikes that could put our capital at risk.

It’s clear our optimum stop must take normal price action volatility into consideration, since that’s what we want to stay away from. Both ATR and PSAR take the normal price action volatility into consideration. The PSAR is a good starting point but it has some problems. In a sideways market, the PSAR can swap back and forth between buy and sell signals and become unreliable. ATR on the other hand is an objective measure of volatility for any situation and since it’s an absolute value number (always positive) it doesn’t matter whether you are long or short, the ATR always is an objective measure of volatility at that point in time. If we start using ATR as our stop setting, we can adjust our stops larger or smaller from that starting point depending on our results. These adjustments will take some time to arrive at manually, but if you can run a simulator you can get there fairly fast. I have found through experience though that 1 X ATR is usually a larger stop than needed with good entries on longer timeframes and it is smaller than needed on shorter timeframes.

So following our theory that a stop should protect us from exposing our capital to sudden unexpected spikes, and yet not get taken out by normal price action volatility, we can measure the pips lost by a stop out due to normal price action volatility and how often it is taken out by sudden spikes and balance these off one another.

Since the price action volatility loss really loses some or all of our potential profit we can’t just count the negative pips or the stop loss as its total loss. We really need to take the average Profit Efficiency that we calculated earlier for these types of trades and multiply that by the maximum profit that was available at any time in this trade to get an estimate of what the potential lost profit was. If we add that estimated lost profit to our stop out loss amount it gives the total damage caused by running the stop too close and being taken out by price volatility. That’s the number that needs to be compared to the spike out risk to arrive at a proper stop amount. Of course, there’s lost estimated profit due to spike outs also. So we have the option of ignoring the lost estimated profit on both sides of the equation, or considering it on both sides to be more precise. Since it adds a lot of complication to the calculation, for the moment we’ll ignore the lost profit on both sides and just consider the stop out losses.

So if our stop was 40 pips and was taken out by sudden spikes 4 times in a month for a loss of 160 pips, but we were only taken out by price volatility from moving our stop closer to price twice in a month for a 80 pip loss, it would make sense to tighten up our stop more until these numbers are closer, so stop could be reset, perhaps from 1 X ATR to 0.8 X ATR. When the spike out loss is equal to the normal price action volatility stop out loss, we can’t adjust either way without losing more on one side or the other. At that point we can say our stop loss is set at optimum.

Or is it? Remember the Tymen’s ocean example? The main tide represents the very long term monthly and weekly charts, the big waves represents the daily, 4H and 1H charts and the little wavelets represents the 1M, 5M and 15M charts? If we’re going to jump into the boiling ocean of Forex, wouldn’t it make sense to know where in the ocean we are? This is the time to do a sanity check of our stop placement. If ATR should give us a good stop out of the way of the wave tops that would take us out of the trade, we can verify that calculation simply by looking at the charts of the timeframe we are trading. Day traders are trading the big waves, so the stop should put us above the tops of the big waves so we can stay in the trades long enough to make a profit and not be taken out of the trade at a profit minimum. But the question has been asked, which chart should we refer to, the 1H or the 4H, and how far back should we look to see if our stop is above the wave tops for a short trade (or below the bottoms for a long trade)?

I don’t know of a one size fits all answer to this question. If someone else has a suggestion I’d be happy to hear it. It’s partly a question of time. The longer we intend to stay in a trade, the more likely we are to be taken out by a peak wave top. I look at my stop placement relative to my entry and what I believe will happen in the trade. Usually I am entering a trade on a break of a retracement trend line or a valid CBL or even better a combination of both signals. When I combine a CBL and the break of a retracement trend line I get a very high win/loss ratio and a very good reward to risk ratio as well. But that’s just my personal method of trading. I like to enter a trade near the middle of the London morning session after some daily direction has formed and stay in that same trade all day, or until the market has definitely turned. All the quick in and outs just don’t seem to work for me. So I’ll want my stop at least above the last lower high for a short trade on the 1H chart, and at most above the last lower high on the 4H chart. That’s consistent with the rule of thumb that a trade should last about 4 to 6 times as long as the home chart time frame. It’s also consistent with Tymen’s rule of placing the stop just above the extreme candle, so if I’m trading a down CBL on the 1H chart, the previous lower high will also be just above the extreme candle. That’s just the way a CBL always works.

So if the ATR tells me my stop should be about 38 pips, and a stop above the last lower high runs 30 to 45 pips, I’d consider that a reasonable sanity check and place the stop just above the last lower high. But if the ATR is 38 and just above the last lower high is 80 pips, that is just too much disagreement. I’ll either wait until another lower high is formed that may be in better agreement or look for another chart to trade or another pair to trade. Often if I just can’t place a stop on the EU 1H that makes sense, I can place one on the 30M chart, knowing that trade may last only a half day, or I may find that EJ has essentially the same chart formation and I can place the stop there. In any case I don’t want to place a stop that is double the ATR as that will produce too low a reward to risk ratio to justify taking the trade. The bottom line here is some trades just aren’t worth taking. The risk is just too high even though everything else looks good. If you run the simulations and delete any trade that has a stop greater than say 1.5 ATR on the chart where the CBL appears, I believe you will greatly increase your reward to risk ratio without affecting your win loss ratio at all. Tightening that constraint further improves reward to risk, but eventually reduces the number of trades available to not be productive in pips won. That has been my experience and I’d be interested in hearing from the simulation experts to see if their work confirms this.

That concludes the philosophy section of setting and using stops. I’d be interested in hearing feedback from any traders including questions, comments, corrections or disagreements. As I’ve said many times, every trader trades differently and I know of no one method that fits everyone, but a good tool that objectively evaluates the efficiency of a traders’ method should apply to any trader or any method. I’ve given some hints on tools we could use for that purpose as we went through the philosophy section. The next section will concentrate on tools that we use going forward to optimize our trading including setting and moving stops.

Thanks again Graviton for this very interesting post!

I think ATR is a very good indicator to determinate if our stop loss is reasonable.
We shouldn´t forget also to look for resistance or support levels like fibonacci retracements and pivot points, trendline, etc. If we are trading short an the ATR is above a very important resistance level, then this will make the SL more reliable. The opposite for a short entry. If we must have 3 reasons to enter a trade, then the same applies for the SL. We must find at least 2 reasons to place the SL.

For me one of the most important things when i enter a trade is that i have an idea of my risk/reward ratio. If i see a good risk/reward ratio i take it.

[dand]

Just wanted to say that I’ve never had anyone approach the subject of stops so thoroughly before - all of the paid tuition/seminars i’ve been to focus on entry signals then generalise the trade management bit. This stuff is priceless - rock on graviton.

[simbafx]

Just wanted to say that I’ve never had anyone approach the subject of stops so thoroughly before

For anyone interested in a more quantatative approach to stop loss analysis I can highly reccommend reading the book titled Maximum Adverse Excursion by John Sweeney, published by John Wiley & Sons.

[Graviton]

For anyone interested in a more quantatative approach to stop loss analysis I can highly reccommend reading the book titled Maximum Adverse Excursion by John Sweeney, published by John Wiley & Sons.

Thanks Simbafx! I’ll give it a read. I appreciate your comment.

[Graviton]

Just wanted to say that I’ve never had anyone approach the subject of stops so thoroughly before - all of the paid tuition/seminars i’ve been to focus on entry signals then generalise the trade management bit. This stuff is priceless - rock on graviton.

Thanks Dand, I’ll be taking care of some other business today, but I hope to return to this subject soon. Happy Trading!

[Loppan]

:)As always Graviton:)!
I just want to chip in my take on a cheap stop big win, too dispel the illussion of big stops beeing a necessity for big wins! Recent EA madness will demonstrate nicely: A 20 pip stop at the top there on a 1cbl squeeze, before the drop!

20pipsl400pipwin.png picture by LoppanFX - Photobucket

Now these things dont happen everyday, and you probably wont get all the pips, but this is something i strive for, small risk big wins:D!