Before we start, I would like to wish all of you a Happy, Safe and Healthy 2012. You can also add prosperous to that list.
I would also like to remind you that our "Best Deal Ever" special pricing ends at the stroke of Midnight tomorrow, December 31st, 2011. Don't miss out! (Actually, as long as the order is there when we re-open for business Tuesday morning, we'll honor it.)
This is the fifth email in our series, "What the Signals Mean."
If you missed the previous four emails you can view them here:
The DecisionBar Trailing Stop Module
While many traders talk about “Trailing Stops,” very few traders know the right way to use them. In fact, one of the biggest mistakes that even experienced traders make is that they don't understand how to place stops as part of a risk reduction strategy.
In fact, most traders actually increase their risk of loss when placing stops. The reason for this is they place their stops according to their personal risk tolerance, not the volatility of the market.
Here's a flash for you: The market does not care how much you can afford to lose!
For an example, lets say you bought 300 shares of a stock to trade on a daily basis. You decide that you can't afford to lose more than $300 on this trade, so you set your initial stop $1 below your purchase price. If you've not done any more analysis than this, you are setting yourself up for almost certain failure.
If you looked a little further, you might have found out that the stock you bought has a random movement (volatility) of $2 a day. The odds are you will be stopped out before you have a chance to profit from your trade. You have stacked the deck against yourself!
To be successful as a trader you must set your stops according to market volatility and control the value of your losses by adjusting the number of shares (or contracts) you buy.
In the example above, you might have bought 100 shares and used a more reasonable $3.00 stop.
The DecisionBar Trailing Stop module includes automated trailing stops based on both a Fixed Distance and on the Average True Range (ATR) of the instrument you are trading.
We suggest you always use the Stop Module in ATR Mode.
The Average True Range (ATR) is a measure of volatility. Essentially, True Range measures the length of a bar including gaps up or down from the previous bar. Average True Range is an average of the True Range of the individual bars over a specified period.
The Stop Module has three settings.
1) The distance of your initial trailing stop.
2) A "Profit Threshold."
3) The distance of your trailing stop once your profit threshold is reached. Once your profit threshold is reached you can exit the trade, tighten your stop, or even lengthen your stop depending on your trading strategy
In addition, the ATR stops have two modes: Regular (“Static”) stops and Dynamic Stops.
Dynamic Stops use the ATR of the previous bar for all calculations. This means your stops will tighten faster, and the actual value of your Profit Threshold will decrease, if volatility decreases. By the same token, your stops will tighten slower, and the actual value of your Profit Threshold will increase, if volatility increases. (Note: Stops are never moved backward.)
On this chart of Light Crude (CL) let's say I wanted to enter long, at the open, following that failure signal on 10/6. The first thing I do is look at the ATR indicator to determine my risk. I see that currently, the market is moving an average is $3.93/day. That's almost 5% per day!
I then have to determine if I want to take the trade, and if I can afford to take the trade with reasonable stop parameters. Big risks can equal big rewards, but I have to adjust the number of contracts I buy so I can keep the trade within my risk tolerance.
Here is the chart with the DecisionBar Stop Module applied. I have set the stops to have an initial distance of 3 ATRs, and to tighten to 2 ATRs when the profit threshold of 4 ATRs was reached. (The value of the current stop is shown by the red dots on the chart below each bar.)
I want to show you one more chart:
Here is what happens when I set the stops to have an initial distance of 2 ATRs, and to tighten to 1 ATR when a profit threshold of 2 ATRs is reached.
By having too tight a stop strategy, I wind up leaving money on the table.
If you are ready to become a successful DecisionBar trader, there will never be a better time than right now to get my DecisionBar trading software.
For details and to sign-up, please visit our website at:
Les Schwartz and the Staff at DecisionBar Trading Software.