Day Trading With Price Action Volume 4 Positive Expectancy (File gốc)

Đối với những Newbie hoặc những bạn tuy đã tham gia thị trường lâu, nhưng vẫn loay hoay chưa tìm được cho 1 mình 1 hệ thống giao dịch phù hợp, hoặc là đã có rồi nhưng vẫn có tinh thần học hỏi, tìm hiểu sâu hơn về nhịp chạy của thị trường, thì theo cá nhân mình thì phương pháp Price Action có lẽ sẽ là 1 chủ đề mà các bạn nên dành thời gian để tìm hiểu. Do đó, hôm nay mình xin chia sẻ với các bạn bộ sách của Galen Woods: How to trade with Price action. Review sơ qua về cuốn sách: 1 – Kickstarter: cuốn này giới thiệu sơ qua về Price Action, các mô hình nến và mô hình giá phổ biến trên thị trường 2 – Strategies: cuốn này nói về 10 system tương ứng với 10 mô hình Price action được nói đến trong cuốn 1 3 – Master: kết hợp mô hình giá với các Indicator, cách nhận diện Trader bị mắc bẫy và cách tận dụng nó để kiếm lợi nhuận,v.v

2 EDITION

Day Trading with Price Action Volume IV: Positive Expectancy

Galen Woods Trading Setups Review Copyright © 2014-2016 Galen Woods

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First Edition, 1 September 2014

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CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED

PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS UNLIKE

AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF

CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO

SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT

OR LOSSES SIMILAR TO THOSE SHOWN

Chapter 1 - Introduction to Positive Expectancy 1

1.1 - Definition of Expectancy 2

1.2 - Definition of Winning Probability 3

1.3 - Probability versus Reward-to-Risk 4

1.4 - Beyond Price Action Analysis 16

1.5 - Conclusion 19

Chapter 2 - Stop-Loss 21

2.1 - Initial Stop-loss 23

2.1.1 - A Method for Losing Small 25

2.2 - Trailing Stop-losses 27

2.2.1 - Price Action Setups 29

2.2.2 - Support and Resistance 31

2.2.3 - Market Volatility 33

2.3 - The Wrong Way to Place Stop-losses 37

2.4 - Consistency of Stop-losses 41

2.5 - Conclusion 42

Chapter 3 - Targets 43

3.1 - The Importance of Profit Targets in Day Trading 44

3.1.1 - Trailing Stop-loss 44

3.1.2 - Profit Target 44

3.2 - Finding Targets 49

3.2.1 - Support and Resistance 49

3.2.2 - Price Thrust Projection 53

3.2.4 - Volatility Projection 67

3.3 - Exiting with a Reversal Signal 70

3.3.1 - Anti-climax Pattern 71

3.3.2 - Merged Congestion Zone 74

3.3.3 - Additional Notes 79

3.4 - Targeting Examples 81

3.4.1 - FDAX 10-Minute Example 82

3.4.2 - ES 10-Minute Example 85

3.4.3 - 6J 10-Minute Example 89

3.4.4 - CL 3-Minute Example 92

3.5 - The Wrong Way to Place Targets 98

3.6 - Conclusion 99

Chapter 4 - The Meaning of Likely 101

4.1 - How to Assess the Probability of Winning 103

4.2 - Conclusion 106

Chapter 5 - Achieving Positive Expectancy 108

5.1 - The Split Second 110

5.1.1 - R2R Indicator 113

5.2 - Complete Trading Examples 117

5.2.1 - CL 4-Minute Example (14 April 2014) 119

5.2.2 - CL 4-Minute Example (1 May 2014) 126

5.2.3 - CL 4-Minute Example (5 May 2014) 133

5.2.4 - CL 4-Minute Example (12 May 2014) 146

5.2.5 - CL 4-Minute Example (15 May 2014) 156

5.2.6 - FDAX 3-Minute Example (8 August 2014) 164

5.2.7 - FDAX 3-Minute Example (31 July 2014) 171

5.2.8 - FDAX 1-Minute Example (20th November 2015) 180

5.3 - Managing Trades for Positive Expectancy 190

5.4 - Conclusion 194

Chapter 6 – The Analytical Cycle 196

6.1 - Establish Rules and Guidelines 199

6.2 - Record Ongoing Analysis 202

6.2.1 - Thought Process for Basic Analysis 203

6.2.2 - Written Analysis as a Tool 205

6.2.3 - Tools for Recording 212

6.3 - Classify Trades 214

6.4 - Review Trading Records 219

6.4.1 - The Holy Grail 220

6.4.2 - Measuring Expectancy 224

6.4.3 - Computing Drawdown (for Position Sizing) 232

6.4.4 - Improving Expectancy 239

6.5 - Refine Trading Rules and Guidelines 253

6.6 - Conclusion 254

Chapter 7 - A Risk-Based Approach to Trading 255

7.1 - Identifying Risks 256

7.2 - Risk Management Card 260

7.3 - Financial Risk 263

7.3.1 - Trading Capital 263

7.3.2 - Living Expenses 265

7.3.3 - Currency Risk 267

7.4 - Operational Risk 269

7.4.2 - Electricity 273

7.4.3 - Internet Connection 274

7.4.4 - Broker 276

7.4.5 - Trading Platform 280

7.4.6 - Execution Process 281

7.4.7 - Trading Environment 283

7.4.8 - Minimise Risk by Keeping It Simple 284

7.5 - Psychological Risk 285

7.5.1 - Psychological Foundation 289

7.5.2 - Practical Strategy 292

7.5.3 - The Final Determinant 303

7.6 - Integration of Risks 303

7.7 - Conclusion 305

Chapter 8 - End of the Beginning 307

Chapter 1 - Introduction to Positive Expectancy

The expectancy of a trading setup refers to the expected

outcome of taking that setup many times over a long period of time The sole aim of every trader is to take setups with positive expectancy in order to accumulate profits Otherwise, your

trading capital will be depleted in a matter of time

Having a positive expectancy is also referred to as having a trading edge Conceptually, it is akin to a casino’s edge Over a large number of bets, the casino expects to make a profit at the gamblers’ expense

As profit-driven traders, positive expectancy is everything

The difference between us and the casinos is that their edge is rooted rock solid in statistics They have rigged the games in their favour, and they know it They can even prove it As for

us, we are trying to rig the game, not quite knowing if we have succeeded It is a much tougher play for traders

So, if you can get over the legal issues and possibly moral

qualms, I suggest that you open a casino rather than day trade futures

When it comes to trading, there are numerous topics covering strategies, indicators, setups, entries, exits, risk management, psychology, software, hardware, and many others Ultimately, these pieces should fit together to help you take trading setups that exhibit positive expectancy

Positive expectancy is the single most important concept in trading Hence, it is essential that every trader has a thorough

come together to highlight opportunities with positive

expectancy While the concept of having a trading edge is

covered in many trading books, most of them do not give it the attention it deserves

The earlier volumes taught you how to analyse market bias and trading setups However, they did not show you how to trade, because nobody can trade without understanding the concept of positive expectancy

To learn how to trade, read on

In this first chapter, we will break down the concept of

expectancy into concrete aspects that we can examine and improve with respect to each trading opportunity The ultimate purpose is, of course, positive expectancy for each trade we take

1.1 - Definition of Expectancy

To this end, we cannot be content with the one-line basic

definition mentioned above Expectancy is more than a fluffy trading concept It is a statistical concept To achieve positive expectancy, we have to understand it statistically

If you did not enjoy your mathematics classes, do not fear There are only three ingredients

 Probability of winning a trade = W

 Reward of a trade = R

 Risk of a trade = L

Expectancy = ( W x R ) – [ ( 1 – W ) x L ]

Both intuition and mathematics tell us that to maximise

expectancy, we need to:

 Maximise the probability of winning a trade (W)

 Maximise the reward of a trade (R)

 Minimise the risk of a trade (L)

It seems like there are three distinct steps to finding great

trading opportunities

1 Find a high probability trade

2 Place our target far away to maximise profit

3 Place our stop-loss near to minimise risk

That sounds simple

Unfortunately, the above recipe is wrong The greater

misfortune is perhaps the large number of traders with this erroneous understanding

To uncover the correct approach, you need to understand the true meaning of winning a trade and the inter-relationships between the winnings odds, our target, and our stop-loss

1.2 - Definition of Winning Probability

Many traders discuss the probability of winning a trade as

though it is independent of its potential reward and risk

That understanding cannot be any further from the truth and is

a very dangerous idea Any discussion of the probability of a winning trade is flawed if it does not incorporate its potential reward and risk It is important to comprehend why

The first step is to understand what it means when we say we

Let’s assume that each time we enter the market, we place a target limit order and a stop-loss order, and we do not adjust them

It follows that for a trade to be profitable, the market must hit our target before hitting our stop-loss If our stop-loss level is hit first, then our trade results in losses and not profits

Hence, the probability of winning a trade is the probability of the

market hitting our target price before hitting our stop-loss point

This is why the probability of winning a trade is not independent

of its target and stop-loss Thus, we must integrate them into a single thought process As mentioned, a useful way to formulate the winning probability of a trade is the “probability that the

market will hit our target before hitting our stop-loss”

This definition offers great insight It shows clearly that the probability of winning a trade is dependent on how well we set our target and stop-loss

1.3 - Probability versus Reward-to-Risk

The next step is to find out exactly how our targets and losses are related to our winning probability

stop-For clarity, let’s start with a completely random market A

random market implies that, assuming there is no slippage and commissions, the long run outcome of any trading strategy is breakeven

PROBABILITY OF WINNING

Probability that the market will hit our target before hitting our stop-loss

Let us establish a long position in this hypothetical market We place a sell limit order above our entry price as our target and concurrently place a sell stop order below our entry price as a stop-loss Our target and stop-loss are equidistant from our entry price

For illustrative purpose, let’s assume that both the target and stop-loss are 10 ticks away from our entry price as shown in Figure 1-1

Figure 1-1 Equidistant target and stop-loss

Since the market is random, the probability that it will move up

10 ticks is the same as the probability of moving down 10 ticks Basically, the probability of either scenario is 50% This means that over the long run and over many such trades, 50% of the trades will make us 10 ticks each, and 50% of the trades will incur 10 ticks of losses each Since the profit per winning trade

is the same as the loss per losing trade, we will end up in a breakeven position (Assuming that that there are no slippages and commissions.)

Entry price Target (50%)

10 ticks

Stop-loss (50%)

10 ticks

Now, let’s consider a trade with a 20-tick target and 10-tick stop-loss What are the odds of this trade being profitable? Is it still 50%?

If it is, according to our expectancy formula, we expect to make

5 ticks per trade (0.5 x 20 – 0.5 x 10) When we say we expect

to make 5 ticks a trade, we mean that our average profit per trade over a large number of trades is 5 ticks

Wow, fantastic Simply by using a larger target, we have

managed to squeeze some money out of a random market

Instead, the market will have a lower probability of hitting our target first and a higher probability of hitting our stop-loss first This is because the distance between our target and our entry price is larger than the distance between the stop-loss and our entry price

The 50-50 probability applies only when the target and the loss are at the same distance away from our entry price (i.e when our reward-to-risk ratio is 1) When we push our target further to 20 ticks away and maintain our stop-loss at 10 ticks away, our reward-to-risk ratio increases to 2

stop-Thus, the probability of the market hitting our target order before hitting our stop-loss order decreases to approximately

33.3% The probability of the market hitting our stop-loss

before reaching our target increases to roughly 66.6%

Figure 1-2 illustrates this change in probability

Figure 1-2 Lower winning probability for higher reward-to-risk ratio

How do we know this? How did we get the probabilities of

Entry price Target (33.3%)

10 ticks

Stop-loss (66.6%)

20 ticks

Expectancy = 0 (Random market)

Reward-Figure 1-3 Decreasing probability with increasing reward-to-risk ratio

This graph illustrates the definite breakeven outcome in a

random market without trading costs like commissions and

slippage The expectancy of every trade is zero and falls on this line

The relationship depicted in Figure 1-3 is intuitive Achieving the target is necessary for winning a trade The further the target, the harder it is for the market to achieve it Hence, the further

we place our target, the higher the reward, and the lower the probability of winning the trade Conversely, if our target is near, our probability of winning increases

Another necessary condition for our trade to succeed is that the market must not hit our stop-loss before hitting our target Thus, tighter stops lower our winning probability because the market has a higher chance of hitting them Wider stops are less likely to be hit by the market Hence, the further we place our stop-loss, the larger the risk, and the higher our winning probability

When we combine these two lines of thought, we conclude that the higher the reward-to-risk ratio, the lower the winning

probability This inevitable trade-off between the winning

probability and the reward-to-risk ratio is an essential trading concept

This random market marks our theoretical start point Now, let’s move on to considering the same relationship in real markets

Does the relationship described above hold true for the real financial markets that we intend to trade?

The efficient market hypothesis is relevant for this discussion I

am not going to expound on the full-fledged theory, and will just present a short explanation before we move on

Basically, the hypothesis states that markets are efficient at

are in doing so, the harder it is for anyone to make money from the market

The underlying explanation is very logical If there is a trading strategy that works, everyone will jump in and trade with that strategy In doing so, the trading edge of that strategy is

eroded

For instance, let’s consider the January effect1 which is the tendency for stock prices to rise in January each year This is purportedly due to income tax reasons The trading strategy to take advantage of the January effect is to buy stocks near the end of the year and sell them in January after the stock prices has risen

However, if everyone employs the same strategy, then they would all buy near the end of the year By doing so, they push

up the prices As a result, the difference between their cost basis and the eventual (supposedly higher) price in January narrows Their potential profit diminishes If the market is

perfectly efficient, this impact will be so pronounced that

January effect simply ceases to exist

In a perfectly efficient market, all information is reflected in its price and movements cannot be anticipated Thus, all

movements are random In that case, the relationship in Figure 1-3 would hold

Everyone who is trying to make money from the market

believes that financial markets are not entirely efficient They believe that inefficiencies of varying degrees exist in the market Some detractors of the efficient market hypothesis go as far as

to say that the hypothesis is wholly wrong and completely

useless

1 First documented by Sidney B Wachtel in his 1942 paper “Certain Observations on

I do not agree with this extreme view The efficient market hypothesis does make sense Its underpinnings are logical and rational Hence, I believe that it is difficult to make money from trading the market and profitable opportunities are fleeting The generally high failure rates of traders and the underperformance

of most fund managers prove this point

At the same time, to believe that markets are completely

efficient is nạve

Thus, a realistic view is that it is possible, although challenging,

to make money from predicting market movements

The relationship in Figure 1-3 holds true in financial markets most of the time However, at times, the market exhibits a kink

in the relationship that offers positive expectancy Those kinks represent the trading opportunities we are looking for

Figure 1-4 illustrates where these positive expectancy

opportunities lie

Figure 1-4 Positive expectancy region on the right of the curve

Recall that the curve represents zero expectancy Note that traders do not start on the line of zero expectancy Due to

trading costs like commissions and slippage, all traders start in the negative expectancy region

Our job as traders is to focus on getting on the right side of the line where we find trading setups with positive expectancy These setups can be the result of a higher probability or higher reward-to-risk ratio or both

A reward-to-risk ratio of 1 paired with a winning probability of 0.5 (50%) produces zero expectancy If there is a chance to enter the market with a reward-to-risk ratio of 1.5 and

probability of 0.5, do we take it? Yes, because it has a better reward-to-risk ratio than a zero expectancy trade It carries positive expectancy

Great, we know where we want to be - on the right side But how do we get there?

Positive Expectancy

Negative Expectancy

The key factor that causes opportunities to open up on the right side of the zero expectancy line is the market bias The market bias denotes a higher tendency of the market to move in one direction, either up or down If the market has no bias, then it is random In that case, there is no money to be made If the

market has a bias and we manage to decipher it, then there is money to be made

Thus, if we get the market bias right, we have managed to

squeeze through to the right side of the graph This is why we devoted the entire Volume II to the art of figuring out the

However, even after we confirm the market bias, we cannot enter the market until we are able pinpoint an exact entry with

a clear reward-to-risk ratio and an acceptable probability

To define our reward-to-risk ratio, we need to find a reliable trading setup aligned with the market bias It will give us our entry price and stop-loss level The difference between them is

our risk

Concurrently, we must figure out where to put our target by

“He will win who knows when to fight and when not to fight.”

Sun Tzu, The Art of War

target projection techniques The difference between our target

price and our entry price is our reward

Then, we can finally put our reward and risk together to find out

our reward-to-risk ratio

How about the probability of winning?

Recall that the probability of winning refers to the probability of the market reaching our target before hitting our stop-loss It follows that the probability of winning depends on how well we select our stop-loss and target

We need a stop-loss that the market is likely to stay away from This means that we need to find a high quality trading setup Then, we need a target that the market is likely to move to, which means that we need to find a magnetic target level that draws the market towards it

Accordingly, to maximise the winning probability, we need to examine how we select our target and stop-loss, and if they are reliable

Summing up the above, we get the correct approach to finding trading opportunities as shown in Table 1-1

No Task Purpose

1 Determine the market bias Open up the possibility of positive expectancy

2 Find a reliable stop-loss point Define risk

3 Find a reliable target level Define reward

4 Determine how likely it is for the market to hit the target

before hitting the stop-loss Define probability

5 Calculate expectancy Evaluate if the trade offers positive

expectancy

Table 1-1 Correct trading approach

We enter the market only if the setup offers positive

expectancy Let’s take a look at our progress with respect to this trading approach

Assessing the market bias is the subject matter of Volume II Return to it if you are still unsure of the techniques for

uncovering the market bias

Items 2 to 5 lay out the roadmap for the first part of this

volume

In Chapter 2, you will learn that a high quality trading setup will provide a reliable stop-loss As we have already discussed the attributes of a high quality setup in Volume III, we will devote our time to learning about alternative stop-loss techniques and their implications

In Chapter 3, you will pick up techniques to identify reliable targets We will rely heavily on our earlier discussion on support and resistance, in particular the different types of swing pivots and the Congestion Zone We will also talk about the importance

In Chapter 4, we will embrace the fuzziness of deriving the probability of winning We ask ourselves what is the likelihood that the market will hit our target before hitting our stop-loss? This is where we decipher the inner workings of our mind in an attempt to arrive at a quantified probability of a successful

trade

In Chapter 5, we will combine risk, reward, and probability using the expectancy formula to decide if a trading opportunity is worth taking This chapter also contains comprehensive

examples to bring you through the entire trading process, from evaluating the market bias to deriving the expectancy of a

trade These important examples serve to reinforce everything

we have learned and show how they fit together to produce profitable trading prospects

1.4 - Beyond Price Action Analysis

The second part of this volume, from Chapter 6 onwards, moves beyond price action analysis Our trading approach creates our trading edge Beyond that, we need to focus on two things

First, we work on improving our trading edge or expectancy We will deal with this in Chapter 6 in which we will focus on keeping good records of our trades and learn how to analyse them to improve our trading performance

Next, we ensure that we are adequately prepared to exploit the positive expectancy of our trading strategy In Chapter 7, we will discuss the three main risks that might affect our ability to trade

First, we must avoid financial risks, in particular the risk

of ruin Every trading strategy suffers drawdowns, including

those with positive expectancy For instance, you have a trading strategy that would cause you to lose $1,000 before making

$5,000 for each traded contract That is a great strategy with positive expectancy However, can you start trading it with

$500?

Clearly not, because if you start trading with $500, there is a good chance that you will run out of money before you can realise the expected profit of $5,000 You will need at least

$1,000, preferably more, for each contract you trade

The basic idea here is that you must have enough money to rough it out before you realise the positive expectancy of your trading strategy It is about surviving until you make it

Hence, we will work on ensuring that you have enough trading capital for the results of a positive expectancy strategy to

manifest, and finding out the position size you can trade given your trading capital

Second, we must be prepared for contingencies during the actual trading process We will identify a list of possible

risks that might affect our ability to trade according to our

analysis Basically, we try to answer the question of what might

go wrong during our trading session

 Will the Internet connection drop?

 Will our broker be unavailable?

 Will your wireless mouse run out of battery?

We will implement a framework for reviewing and handling such risks

In doing so, we will establish standard trading procedures and controls to govern our actual trading process This is essential to ensure that we are able to take advantage of the good trades

we identify

We must know what trading aids to place on our charts and which screen to pay attention to at which point in time When a trading opportunity with positive expectancy arises, you must know exactly which button to click and be able to click it without

a family member barging into your room

Focusing on the things that might go wrong helps us to drill down to the tiniest detail in our trading process and hammer them out clearly Only then, we are able to act without

hesitation or interference when a trading opportunity arises

Third, we need to manage the risk of emotions running amok We will face a trader’s worst psychological demons

Very often, taking negative expectancy trades is not fatal, as long as the good trades more than make up for them What is fatal is giving in to the fear and greed and other mental demons that cause you to neglect all the trading principles you know That will lead you will ignore the trading rules you’ve set for yourself and trade excessively To realise the positive

expectancy of our trades, we must keep our emotions, chiefly fear, in check

It is important to understand that managing these three types

of risks merely enable us to take positive expectancy trades Managing them does not create a trading edge It merely

preserves our trading edge, if we indeed have one

Having a lot of money will not help you make more money if you do not have a trading edge You’ll just survive longer as a losing trader (Okay, with a lot a lot of money, you might create

a trading edge to make money But most ways of doing that are illegal.)

Maintaining iron-clad discipline to take negative expectancy trades will just deplete your trading capital in an orderly fashion

However, these aspects of trading are almost as important as the analytical aspects because without them, you are unable to realise the results of your market analysis And if you do not pay attention to them, you may end up eroding your trading edge In all, these factors are necessary but not sufficient for trading profitably

1.5 - Conclusion

The most important concept in this chapter is the definition of the probability of winning

It is the probability of the market reaching our target price

before hitting our stop-loss

This single concept enjoins our entry, stop-loss, and target, and

is extremely instructive on the right way to find solid trading setups

Taking trades with positive expectancy is our sole purpose Every single aspect of our trading plan must bring us closer to doing so

Chapter 1 to 5 of this volume is on how to find trades Chapter 6 and 7 discusses the business and psychological aspects of

trading I’ve chosen to combine them in one final volume to highlight an often neglected fact – trading is more than just your trading strategy

Your strategy, process, and psychology fit together to produce the elusive positive expectancy

 Prepare yourself financially, operationally, and mentally

Chapter 2 - Stop-Loss

Stop-loss orders are orders placed to limit our loss in the event that the market moves against us Typically, they are placed as stop orders after our market entry

Stop-loss is not a popular topic Some new traders are not even aware of the concept of stop-losses, and many traders often avoid talking about it This is because stop-losses are associated with losing It is never good for business (and ego) to discuss too much about losing in the market At best, these traders treat stop-losses as an invisible but necessary evil If we adopt this attitude, we will miss exploring a crucial aspect of trading

Of course, I do not like to lose as well However, losing is such

an important theme in trading that we should pay it proper attention To a large extent, trading is about losing right, and losing small And stop-losses are our best tool to achieve this

How do we lose right?

Losing right refers to losing as part of a set of consistent trades with positive expectancy Within a set of trades with positive expectancy, we expect overall gain

However, we are also aware that not all trades will be profitable There will be losing trades These losing trades are desirable because they accompany winning trades that surpass them in

LOSING MONEY CORRECTLY

Trading is about losing right, and losing small

Hence, to ensure that we lose right, we must focus on taking positive expectancy trades As long as we are doing so, even if

we are stopped out, we know that we have lost desirably

How do we lose small?

Small is a relative concept It is relative to the size of the

potential profit The smaller the potential loss, the larger

reward-to-risk ratio It is also relative to the winning probability Hence, to find out how small is enough, we need to plug our potential loss into the expectancy formula This will be done in Chapter 5

Stop-losses help us lose correctly and lose small It also means that a stop-loss serves two competing aims

It should help us lose small and limit our losses.2 This implies that a tight stop-loss is desirable

However, it should help us lose right To do so, it must allow enough room for a good trade to unfold and hit the profit target despite market fluctuations This means that the stop-loss

should be placed at a safe distance away

Given these considerations, setting a stop-loss is delicate

business The ideal stop-loss level is the tightest one that offers enough room to accommodate reasonable movement against your trading position

What is considered reasonable movement against our position?

2 Stop-loss orders are generally not guaranteed They take the form of stop orders When the market hits the specified price, the stop order turns into a market order to be executed immediately However, the exact execution price depends on market

conditions Thus, although stop-loss orders help to limit our losses, they do not

I do not have a straightforward answer for you But I can tell you that it depends on three factors: price patterns,

support/resistance, and volatility

In the following sections, we will examine the impact of each factor on our stop-loss placement

2.1 - Initial Stop-loss

The probability of winning a trade is the probability that the

market will reach our target before hitting our stop-loss

The stop-loss plays an important role in our search for high probability trades We need to find a reliable initial stop-loss level for each trading opportunity

What is a reliable stop-loss?

In the context of a long trade, a reliable stop-loss level is one that the market is more likely to stay above For a short trade, the market tends to stay below a reliable stop-loss level In addition, a reliable stop-loss level is one that signals that our analysis is wrong when the market hits it

Recall that in our price action framework, we always place the stop-loss order a tick below the setup bar for a long trade and a tick above the setup bar for a short trade

This is because our setups are based on price points where we believe buying or selling pressure will take over and push the market to our advantage Hence, if our trading premise is right, the opposite extreme of the setup bar is a reliable stop-loss point

Thus, the reliability of our stop-loss depends on the quality of

introduction of the previous volume The analysis of the market bias and trading setups covered in the last two volumes will help

us to find reliable stop-loss points

Finding a good trading setup gives us an entry point More

importantly, it gives us a reliable stop-loss level

To find reliable stop-loss points, look for high quality setups in the direction of the market bias The quality of the setup

depends on the support/resistance areas, confluence of price patterns, and the form of the setup (Refer to Volume III

Chapter 19 for details.)

Re-entry equivalent setups also offer quality trading

opportunities (Refer to Volume III Chapter 12 for details.)

Price action setups, market volatility, and support/resistance affect how we place our initial stop-loss However, I recommend using price action setups for initial stop-loss placement as it offers a direct way to link our entry conditions with our exit strategy

So far, we have been using a price action setup as our basis for placing initial stop-loss We consistently place our stop-loss a tick below a long setup bar or a tick above a short setup bar Moreover, we do not adjust it regardless of the price action that follows after our entry

This is passive trade management, which refers to keeping our stop-loss and target constant regardless of how the trade

progresses The implication of passive trade management is that

we maintain a fixed reward-to-risk ratio for each trade Having a fixed reward-to-risk ratio simplifies the calculation of expectancy and makes it easier for us to assess if a trade has positive

expectancy

2.1.1 - A Method for Losing Small

I mentioned that we want to lose correctly and small So far, we have been focusing on finding reliable setup bars and placing our stop-loss around them This helps us to lose correctly

To lose small, I have a simple method for you

Take only narrow range setup bars

To define a narrow range bar, use a long-term moving average

of bar range as a benchmark Any bar with a range below the benchmark is a narrow range bar (We will use this definition again when we learn to trail stops using market volatility later.) What is a long-term moving average of bar range?

It is a moving average that uses bar range (bar high – bar low)

as its input It is not a standard indicator on most trading

platforms.3 However, if your trading platform allows you to nest indicators, you can set it up easily Simply set bar range as the input of your moving average indicator

For the look-back period of the moving average, use the total number of bars in five trading sessions The moving average will then include five complete sessions and account for any day-of-the-week nuances in volatility

For instance, in an hourly chart showing 24-hour trading

sessions, we would use the average range of the last 120 price bars (24 hourly bars x 5 trading sessions)

Narrow range bars are favourable setup bars for two reasons

First, as our trade risk is determined by the bar range, a narrow range setup bar means a lower trade risk

Next, assuming that the market continues to move with the average volatility (bar range), it produces a better reward-to-risk ratio Generally, a narrow range setup bar in a volatile

market is likely to enjoy a higher reward-to-risk ratio

These reasons explain why there is a variety of price patterns surrounding narrow range bars like the NR4 and NR7.4

(If you use the R2R indicator to project minimum targets, you may choose to hide the targets for wide range bars by

specifying the appropriate look-back period Learn more in

Always assess the quality of the setup first Then, use the bar range as a filter If the bar range is too wide and the trade

entails too much risk, skip it

Next, this technique is an extreme measure to lose small When applied rigidly, it might cause you to skip many high quality trades that happen to have wide range setup bars Hence, weigh your decision against the quality of the trading setup If the trading setup is fantastic, a wide range bar might be acceptable

4 Refer to Toby Crabel’s Day Trading with Short Term Price Patterns and Opening Range

If the trading setup is of average quality, insist on having a narrow range setup bar

Finally, in your attempt to make use of narrow range bars to control risk, be aware that narrow range bars often occur in congested markets Hence, if you see too many narrow range bars too frequently, consider avoiding the possibly congested price action instead of jumping into the market

Trailing a stop-loss always refers to moving the stop-loss in the direction of the trade You can move the stop-loss closer to the entry price to lower the trade risk You can also move it to lock

in profits once the market has moved in your favour by a

reasonable margin

However, under no circumstances should a stop-loss be moved against the direction of the trade For instance, in a long trade, the stop-loss order should never be moved to a lower price level It should only be shifted upwards

As long as the stop-losses are adjusted based on price analysis, trailing stop-loss is a valid technique However, it should only be used by experienced and proficient traders This is because there are two significant drawbacks that might bring new

traders more harm than good

First, it is generally more challenging to control your emotions

and conduct solid analysis leading up to your trade entry But after you have taken a financial interest in the market, your emotions and cognitive biases tend to flare up Your perspective becomes anchored to your entry price Your mind is fixated on not becoming a loser It becomes a lot harder to analyse the market clearly Without proper analysis, you will not be able to adjust your stop-loss with sound reasoning You end up

adjusting your stop-loss emotionally, and not analytically

Even if you are able to control your emotions when it comes to trailing stop-losses, you will still need to deal with a technical difficulty

With simple passive targets and stop-losses, calculating the expectancy of a trade is straightforward as we have a fixed reward-to-risk ratio for each trade However, with trailing stop-losses, our reward-to-risk ratio fluctuates throughout the trade This varying reward-to-risk ratio has a profound impact on our trade's expectancy

We might get stopped out with a smaller loss or with a smaller gain By adjusting the stop-loss, we also inevitably affect the probability of winning If we trail the stop-loss too tightly, we decrease the probability of winning If we trail it too widely, we increase the probability of winning but might decrease the size

If you are game for trailing stop-losses, you may employ the following techniques to do so

2.2.1 - Price Action Setups

Since we place our initial stop-loss based on a price action

setup, there is no reason why we should not adjust them

according to subsequent new setups

If a new long trading setup forms while we are in a long trade,

we have the option of moving our stop-loss order upwards to just beneath the setup bar of the new long setup This will

tighten our stop-loss and decrease our potential trade risk Similarly, a new short trading setup in a short trade gives us the option of shifting our stop-loss down

Conceptually, trailing a stop-loss based on a trading setup is no different from entering a new trading setup We are merely taking into account a setup that occurred when we are already

in the market In fact, if you are not trading your maximum number of contracts, other than shifting the stop-loss order, you can also add to your position according to the new setup

Thus, in deciding if you should trail a stop-loss according to a new trading setup, consider the quality of the setup A good setup implies a good stop-loss level Hence, evaluate the quality

of the new setup The better the quality of the setup, the

stronger the case for trailing your stop-loss

Figure 2-1 shows an example of trailing a stop-loss down in a short trade as a bearish Pressure Zone setup occurred

Figure 2-1 Trailing a stop-loss down with a bearish Pressure Zone

1 The market bias was bearish Hence, we sold a tick below this bar due to the bearish Congestion Break-out Failure As usual,

we placed a stop-loss order a tick above the high of the setup bar

2 After moving down for two bars, the market reversed up and went right up to the high of our setup bar, which was just a tick below our stop-loss order Although that caused some traders to hold their breath for a moment, price soon fell

3 During the descent, a bearish Pressure Zone formed This Pressure Zone formed right after price was rejected from the high of our original setup bar In addition, the last bar of the Pressure Zone was a powerful bear trend bar

Hence, we adjusted the stop-loss order down to just above the last bar of the Pressure Zone This new stop-loss level helped to lock in a 2-tick profit without stifling the setup’s profit potential

2 Stop-loss order almost hit

1 Bearish Congestion

Break-out Failure;

shorted here

3 Bearish Pressure Zone

4 Trailed stop-loss here

2.2.2 - Support and Resistance

We can find support and resistance with swing pivots, trend lines, and Congestion Zones Technically, we can trail our stop-losses according to any type of support and resistance in long and short trades respectively However, basic and tested pivots are usually less reliable for trailing stop-losses

Hence, I recommend the following price action formations for the purpose of trailing stop-losses

 Valid pivots

 Pivots with Congestion Zones

The first method simply trails the stop-loss order a tick below a valid low for long trades, and a tick above a valid high for short trades (If you are not sure what a valid pivot is, refer back to Volume II Valid pivot is the most reliable type of pivot and often acts as major support/resistance.)

The second method is an effective trailing stop-loss technique that uses Congestion Zones to find reliable pivots as stop-loss points Basically, for long trades, we wait for price to clear

above a Congestion Zone before bringing our stop-loss to the nearest pivot low below the Zone For short trades, after price clears below a Congestion Zone, we bring the stop-loss to the nearest pivot high above the Zone

This technique is demonstrated in a long trade in Figure 2-2 The dotted boxes in Figure 2-2 represent Congestion Zones