Friday, September 7, 2007

Forex Money Management How To Place Stops and Maximize Profits

Many traders are right about market direction enter a trade and then get stopped out then see it go onto make thousands or tens of thousands of dollars and there not in.

Welcome to the world of forex trading.

The fact is placing stops is in my view the hardest part of trading. Lets look at it in more detail.

Lets dispense with a couple of myths first.

1. FOREX brokers hunt stops.

As trillions of dollars are traded each day no broker is big enough (and no they dont all group together) to move the market to pick off your stops.

You are simply subject to market movement and the volatility that is inherent in trading forex markets.

2. A tight stop is better as there is less risk

Not necessarily so, this is the myth of day trading.

Trade with a tight stop in a short time frame and you have less risk.

Not true. Volatility again is totally unpredictable in short time frames and most day traders near enough guarantee a loss albeit a small one.

However there is no point using a tight stop if you almost guarantee a loss every time.

Ever seen day traders make money?

Well the above is one of the major reasons why.

So how do you place stops?

There are many different ways, but here are some observations as they relate to long term trend following.

1. Support and resistance

Yes, good old fashioned support and resistance is a good way to place a stop.

If for example you are trading a breakout and you think its valid the stop is behind the breakout point.

2. Never move a stop to soon

Many traders trail stops to lock in profits and this is a critical error even experienced traders do.

This in most cases simply sees them stopped out by volatility and reactions to the major trend.

They then end up with marginal profit and miss the big trend.

If you are long term trend following and have confidence keep the stop back and take dips in open equity, this is the only way to hang onto to the really big trends so get used to the feeling, its not nice and you need lots of discipline.

Keep your eye on the big picture and it will be worth it in terms of profit.

3. Dont use indicators for stops

While you can use momentum and other indicators to enter trades and determine price strength and value areas never use them for stop placement.

We love the stochastic but as price indicator but would always use chart support and resistance first.

Bollinger bands are really for defining volatility and value areas it should not be used for stop placement on there own. Keep in mind Bollinger bands used in isolation would re set stops everyday and could create a huge loss.

My own view is support and resistance is the simplest and easiest way to place stops.

Another way is to use a straight monetary loss

I know someone who simply placed a $500 dollar stop from entry. I never knew how his system worked but it certainly worked for him.

The fact remains stop placement is one of the hardest parts of trading forex and there are many ways to do it and we have only touched on the subject here.

Our view

We normally trade breakouts that have been tested numerous times i.e. when a break comes there are high odds of an acceleration of price in the direction of the break.

This means the stop can be simply tucked in below the breakout point meaning risk to reward is good.

This allows a tight stop with great profit potential and we never move it to quickly if we think a good long term trend is developing.


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