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All successful traders understand how to limit their risk in order to protect their trades.
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The other day one of my students asked me an interesting (although not uncommon) question "Do you get charged money every time you move your stop?" Of course the answer is no, but the very question must mean that there is still a lot of confusion out there about trailing stops.
A trailing stop is also called a stop-loss order, which is placed with your broker, whether via your trading platform or a phone call. If you are long the mini-S&P (ES) for example, the trailing stop takes you out of the trade once the ES reaches a certain price. A stop-loss is designed to limit a trader's loss on either a long or a short position.
The trailing stop "type" you choose should be one that you will stick with -- no questions asked. There are dozens of different ways to set your trailing stops and here are a few: percentage of the security (a stock for example), a set number of points in the ES, using momentum, based on the trade's set up, and many others. The main trailing stops we use in the chat room are stops based on the trade's set up and trailing stops based on momentum.
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Let's say we have a buy set up that was triggered by our system based on a chart pattern. This chart pattern may have a low in the ES of 1400.00, so when we buy the ES we will automatically place a (trailing) sell-stop below 1400.00. For example, we may place the sell-stop at 1399.75 or 1399.50, but we will place it.
Once the ES rallies 3.00-points we automatically move that stop to break-even in case the market makes a sharp reversal. In both instances, initially and once it is moved, we are protecting our capital. If the ES continues to rally, we can keep raising out trailing stop based on the chart formations in order to (in this case) protect our open trade profit.
The other main type of trailing stop we use in the day-trading chat room is the momentum stop, which is a little more advanced; this trailing stop is automatically calculated by an algorithm in our trading software that measures the velocity of the market as well as the average true range of each bar. Once each bar closes, the algorithm instantly calculates a new trailing stop that helps us both protect profits and protect our equity if the trade results in a loss.
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Whichever type of trailing stop you choose doesn't really matter; all of them will allow your decision making to be free from any emotional influences. People tend to fall in love with their trades, believing that if they give just a little more time, it will come around. This causes procrastination and delay, giving the stock yet another chance and then yet another. In the meantime, the losses mount! The point here is to be confident in your strategy and carry through with your plan. Stop-loss orders can help you stay on track without clouding your judgment with emotion.
A stop-loss order is such a simple little tool, yet so many investors fail to use it. Think of a stop loss as an insurance policy: you hope you never have to use it, but it's good to know you have the protection should you need it.
Consider this: I have a friend who is a very active trader and has never used trailing stops. Only now, after draining a $100k account to just $8k did he tell me, "I guess I should have listened to you about using trailing stops two-years ago." Soon his account will be at zero -- he still refuses to use stops...and refuses to follow the trend.
Trade well and follow the trend, not the so-called "analysts/experts."
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About the Author
Larry Levin is the Founder & President of Secrets of Traders - a commodity trading educational firm dedicated to helping traders succeed in the futures markets. He has been in and around the S&P 500 futures pit at the CME for almost 20 years, where he started as a runner for Lind-Waldock. Larry moved up through the ranks from runner to phone clerk to desk manager of the S&P desk. He began trading his own account in 1994.
In 1998 he formed Trading Advantage, a publishing company enabling him to distribute his self-authored trading course, The Secrets of Floor Traders. In 2000 he sold the rights to the course Secrets of Floor Traders to Secrets of Traders, LLC to market his products for him. This transaction has allowed him to trade for a living full time while continuing to distribute his message. He recently developed his newest trading course, 'The Secrets of an Electronic Futures Trader'; an interactive, self-paced Training Program to give the electronic futures trader the competitive edge needed to succeed.
Larry appears regularly on CNBC, Bloomberg Television, Rob TV, BizRadio, as well as various other media outlets, providing his expertise and insight on the current market.
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