Follow us on Twitter @Schwab4Traders. This blog updates the first Tuesday of the month; next installment publishes February 12th.
When you’re constructing your trade, consider beginning with your end. That is, where do you see your downside risk? If you’re just getting started in trading, this can be as easy as a percentage or dollar amount from your entry point. A more advanced approach might rely upon support and resistance, in addition to other technical indicators, to assist in determining where to set the stop exit order. Regardless, using a stop order of any kind is a step in the right direction.
Let’s suggest you’re considering a stock trading at $200 per share. If you’re a long-term trader, you might have comfort with a larger percentage of risk and willing to give up as much as 10%, or $20. If, however, you’re looking to hold this stock for only a few days, your risk might be much less at 3% or $6. Volatility should also play a part in helping you determine how much to give up with this type of stop order. A method for determining this is the Average True Range (ATR) study. This is the average daily high/low spread of the stock for the defined time frame (default is 14 days). You may choose to customize this time frame to meet your trading time horizon.
Once your downside exit price is set, you know where you’re placing your stop order. Whether you place the stop as part of your primary order or add it after your initial purchase, relying on stops to take you out of your position as it moves against you is a key component to your long-term trading success. You will have profitable trades and you’ll have losing trades.
In order to be successful over many years of trading, work to take small losses and hold your profitable trades as long as possible.
When using StreetSmart Edge®, you can incorporate this risk process into your primary trade. The All in One Trade ticket has this function built in:
Source: StreetSmart Edge®
This allows you to enter a limit order for the current day, log out of StreetSmart Edge, and remain protected should your order execute. These ‘contingent’ orders are good forever and stay active unless you remove them. This differs greatly from a standard sale order which is good for a maximum of 60 days if designated as ‘Good ‘Til Canceled’ (GTC).
In this example, we used a standard percentage from entry price as our risk and target parameters. This is an adequate way to begin establishing your risk tolerance. Alternatively, you can work with a flat dollar amount from entry or analyze the chart and define the target and stop levels based on historical prices for the stock in question.
Risk management is the key to a trader’s long term success. It’s a frequent topic of conversation in many of our webcasts, notably Trader Talk in Today’s Market. If you’d like to see this topic in practical terms, join one of our daily sessions and participate in the live Q & A.