After The Setup: How To Enter, Place Stops, Trail Stops and Take Profits
Many are obsessed with finding the next
setup. However,
this is only one part of the trader’s equation. After the setup, you have to
enter, set a protective stop, trail your stop and take profits. Below we will
discuss these variables and will walk through several examples from a swing
trader’s perspective.
The entry
In many cases, the setup “triggers†when it trades
above the prior day’s high. This means that if the stock made a high of 51
today, then you would go long tomorrow if and only if the stock traded
above 51, say at 51 1/16 or higher. Often, a bad trade can be avoided by simply
waiting for the setup to trigger.
Other possible triggers include a rally above prior resistance or wherever the
setup dictates.
The Initial Protective Stop
(IPS)
There are various theories about where the IPS should
be set. It can be pattern-based, volatility-based or dollar-based.
Pattern-based stops usually go below a significant
low. For instance, setting your
stop below recent support, the low of a breakout bar or the low of a pullback
are several examples of “pattern-based†stops.
Volatility-based stops seek to determine the normal volatility of the market and set your stop outside that level.
The theory here is to avoid being stopped out on noise alone.
Dollar-based stops are set at some fixed point away from
the entry. Usually they increase
with the timeframe of the trader. For instance, daytraders might only risk 1 point per trade whereas swing traders might normally risk several points per trade.
In the markets, there are no “exacts.†Therefore
it becomes a matter of personal preference as to where the IPS should be placed.
You are less likely to get stopped out when using volatility to set stops, but when you do, your losses will likely be significant when stopped out. A daytrader
may be forced into dollar-based stops to keep risk per trade within reason.
Pattern-based stops have the advantage of market structure (i.e., support) but
like the volatility-based stop, losses can often be quite large.
Taking
profits
Once you’re in a swing trade, you have to determine where you
are going to take profits. Many
think they have to be perfectly right by selling all of their position at the
exact high. Nothing can be further from the truth. Trying to catch the exact
high is psychologically a loser’s game. Further, even the best professionals only
occasionally catch the exact high. And most will admit that when they
do, that it was pure luck. The
objective of trading is to consistently make money. The objective is not to be
right.
A simple, yet effective, money-management technique for the
swing trader is to sell half of your position as soon as your profits exceed
your initial risk. Larry Connors has dubbed this 2-for-1 Money Management.*
Let
it ride
The old Wall Street adage of letting your profits run is
one of the few adages that actually makes sense. The easiest way to do this is
to trail a stop. In other words, tighten the stop as the position moves in your
favor. This way, when the stock
reverses, you’ll hopefully lock in a significant portion of the open profits.
Examples
Let’s look at some examples based on the above. For
purposes of this article, our entry is above the prior day’s high or where the
setup suggests, our initial
protective stop (IPS) will be pattern-based and placed below the low of the setup
or below a two-bar low in extreme cases, 2-for-1 money management will be used and a two-bar low trailing stop
will be used for the remainder of the position.
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1. Aviron
(
AVIR |
Quote |
Chart |
News |
PowerRating) sets up up as a mini-pennant–a setup Jeff Cooper has dubbed a Boomer.
Go long tomorrow at 43 1/16th, 1/16th above today’s high.
2. The stock trades
at 43 1/16th and we go long.
3. Place a
protective stop below the low of the setup at 41 7/16 for a total risk of 1 5/8
points.
4. The stock hits
the 2-for-1 profit target by trading 1 5/8 points (our initial risk) above our
entry. Exit half of the position and move the original stop up to
breakeven–(2), the same as our entry.
5. The stock
implodes and stops us out at 43 1/16 for a scratch on the remaining shares. As
you can see, what could have been a losing trade, turned out to be marginally
profitable through money management.
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1. Tut Systems
(
TUTS |
Quote |
Chart |
News |
PowerRating) sets up as a three-bar pullback from highs. Go long tomorrow at 96
3/8, 1/16th above today’s high.
2. The stock trades
at 96 3/8 and we go long.
3. Place an initial
protective stop (IPS) at 93 13/16, 1/16th below the low of the pattern, for an
initial risk of 2 7/16.
4. The stock trades
2 7/16 above our entry so we exit half of the position and move our stop to
breakeven (2).
5. The stock sells
off and stops us out of our remaining shares for scratch trade. The stock
eventually goes higher–but that’s life!
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1. Cache Flow
(
CFLO |
Quote |
Chart |
News |
PowerRating) set up as a Trend Pivot Pullback. According to the rules of
the setup, go long 1/16th above the pivot high. Therefore, go long at 96
9/16.
2. The stock trades
at 96 9/16 and we go long.
3. The low of the
setup is over 8 1/2 points away. This is somewhat of an extreme level.
Therefore, initial protective stop is placed at 90 11/16, below the two-bar low, for a total risk of 5
7/8. Note: Swing traders willing to re-enter if stopped out may go with a much
smaller dollar-based stop, say 2 points.
4. The stock trades
5 7/8 points above our entry and we exit half of our position and move our
protective stop to breakeven (2).
5. The stock
continues to move in our favor so we trail the stop at two-bar lows.
6. The stock trades
below the two-bar low and we are stopped out at 109 3/16 for a profit of 12 5/8
points on the remaining shares.
More
information
As you can see, there’s a lot more to trading than just
finding setups. Above, we have only scratched the surface of what happens after
the setup. For more information on money management and managing the position,
refer to the following articles:
Money
Management (Pt. I): Controlling Risk and Capturing Profits, Dave
Landry
Money
Management (Pt. II): Rules Of The Road, Dave Landry
Money
Management (Pt. III): Insights From The Pros, Dave Landry
Money
Management (Pt. IV): Pro Traders Share Their Lessons, Dave Landry with
Kevin Haggerty and Jeff Cooper
Position
Management (Part I): Initial Stop Placement, Dave Landry
Position
Management (Part II): Trailing Stop And Exit Techniques, Dave Landry
Trailing
Stop Techniques, Mark Boucher
Ten
Tenets Of Swing Trading, Dave Landry
*Connors On Advanced Trading Strategies, Larry Connors