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The problem is that you don't know the expectancy of your system, so every trade becomes a gamble. Since you don't know the historical probabilities of 10 trades, 100 trades, etc, then you want to make sure you get a little piece of green whenever you see it because you don't know how much green you might get again.
If you know historically your method wins 7 of every 10 trades, then when a trade starts to go green, then you will be fairly confident it should be one of the 7 winners, and if it turns red, you will be fairly confident it might be one of the 3 losers, the majority of the time. You know you don't need to worry until you get to 6 losses in a row (if you trade with a 1:1 reward/risk), because that is the point where you are guaranteed a losing day or a tough battle back. If your method can support a 2:1 reward/risk, your odds improve significantly. This should give you peace of mind. Every trader should know the expectancy of their method. If you don't know, you are gambling.
Sticking to the exit theme, here is an alternative approach to managing exits.
The exit rules posted earlier are generally scalp trades, a few ticks here and there. This same setup can be used with an exit method that holds for larger moves.
Attached is a chart showing the basic method. Enter as normal, with the intial stop placed where it would normally be placed. Then, instead of taking profits at the usual spot (the outer envelope for trend trades), hold the trade through any retracements to the SMA. Trail the stop down to just beyond each swing high/low that is made during the trend. Expect to be taken out via the stop, unless price approaches a logical support/resistance line before that time, at which point you can take profits.
The attached chart shows a trade that I took today using this method. I was expecting a larger down move than we ended up getting, and so I wanted to give this trade room to develop. My stop was eventually taken out for about a 20 tick gain. Not an enormous gain in this case but if you happen to catch a good move, this method can produce huge winners.
One more word about exits. I think it is important that some of your winning trades be allowed to run much further than the size of your average loss. This is a difficult lesson to learn but nothing makes an account grow faster than a winning trade that's equivalent to five losses.
How do you know when to take "scalper" profits versus when to let a winning trade run? Unfortunately, there is no easy rule that I'm aware of. There is no substitute for awareness of the broader macro conditions that are impacting the market each day. What is the dominant trend on the daily chart? Is the market below or above the nearest support level? Is volatility high, indicating heightened fear and a tendency for quick down moves, or low, indicating complacency and an upward bias? Has the market just broken out of a congestion zone?
I would offer the following general observations about when to let trades run:
1. If the market is selling off, is in a downtrend on the daily chart, and volatility is high, I look for short setups that I can allow to run. Be aware of resistance areas and try to enter on a downtrend that establishes itself after a bounce down from a resistance area.
2. If the market has been stuck in a tight congestion range for some hours (or days), a breakout of that range can yield a longer trend than normal.
3. Similarly, a breakout from a triangle pattern on a longer timeframe chart can produce a good opportunity for "runners."
4. If the market is in an uptrend on the daily chart and volatility is low, most trends will run farther than you'd expect. Trade in the direction of the trend and stand aside. Take profits at the next support/resistance area based on reversal points from the past few days of trading. If you draw these lines on your chart in advance, it's eerie sometimes how they seem to work like a charm. Again, this trick tends to work in low volatility environments but not high volatility, when price has a tendency to reverse and give more "head fakes."
5. I am not a fan of multiple contract trades where part of the position is exited after a small move. I recognize that this is a popular trading style since it seems to allow you to "take away the risk" of a trade very quickly, and then let the remainder of the position run. My problem with this approach is that it screws with the average size of your winning trades in a way that makes it very difficult to get ahead. All of your losses will be on multiple contracts, while many of your wins will be on a single contract. You will find yourself with lots of sequences of trades where you lose 16 ticks on a loss and make 8 back on a win. It's better in my opinion to train yourself to treat the full position as a "runner," or alternatively to take partial profits only after a large move, like twice the size of your stop.
So far we have discussed how to use this tick chart setup to gauge the state of the market (trending; chopping; overbought; oversold), and have also discussed a few basic entry setups and exit methods.
This quiz includes questions probing each of these areas: state of the market, entries, and exits. I'd be interested not only in your answers, but also why you answered the way you did.
Question 1: I would say this is chop. I see one possible short and one long trade. Profit targets would be the inner envelopes on the opposite side.
Question 2: I guess you should not exit now. I would place the stop 1 tick below the last swing low > below the doji at around 12,435
Question 3: I would not enter long at this point. Perhaps try a countertrend trade with a small stop, target SMA. Or do nothing at this point and wait for a retrace to the SMA after the breakout and look for a possible long entry at the SMA. But it´s really hard to decide for me at this point. I´m eagerly interested in your opinion.
Q#1. I usually consider such PA as a pattern of continuation to the upside. You can clearly see a falling channel, i would have drawn a falling trend line on the highs and waited to enter long on a break out of this line. The double bottom forms a W shape where some short traders got trapped.
Q#2 i would exit if price would close below the MA
Q#3 As we just broke above a resistance 4th attempts then i would place a limit buy order possibly 1 or 2 ticks above previous resistance.
Thanks to those who responded to the latest quiz. I'll leave the questions up one more day in case anyone else wants to take a crack at it. The questions are more difficult this time, without black-and-white answers.
Now that I've introduced the basics of the setup, I plan to use the rest of the month to highlight charts from each day to see how the setup might have informed trading.
Today is a tricky day to start. I had a hard time getting in synch with the market today. It was mostly an uptrending day, but the uptrend unfolded in segments, with a pause in between each upleg that was just deep enough to look like the trend might be rolling over. I found myself headfaked a few times. The best trading opportunities of the day came in the chop in the final hour or so.
If anyone has any specific questions about today's action, please chime in.
1 chop within up trend..
2 dump the sucker...(was gambling to me, would wait for better setup)
3 wait for retest of s/r it just broke through and go long
That wouldn't take long as I actually took only two trades today, both stopouts. I shorted YM around 2:15 ET at 11995; this looked like a promising short trend setup. (I hadn't traded earlier as I wasn't seeing any crystal clear setups; something about the day felt fishy to me and I couldn't get in synch.) I was stopped out for a few ticks' loss when the swing high was broken a few bars later.
I then tried to short the subsequent push into the 12010 area. My idea seems to have been sound but my timing was early; the move down into the lower envelope that I'd anticipated did play out, but not until it stopped me out first. Today I'll take my losses and see if anything better shapes up tomorrow.
