Dave Landry On Laying The Foundation For Successful Swing Trading, Part II
Placement of the initial protective stop
is as much of an art as it is a science. Too close and you will almost surely
guarantee yourself a loss as the “noise†of the market will stop you out.
Placing it further away will increase you chances of a winning trade should the
trend resume, but obviously increases your risk if it doesn’t.
When trading pullbacks, the low of the
pullback is the obvious place for a protective stop. However, because this is
common knowledge, it becomes a target for market makers. Therefore, I like to
use a somewhat looser stop (especially if the low of the pullback is fairly
close), taking into consideration the volatility and price of the stock (higher
priced/more volatile stocks require a looser stop).
The following table is a general
guideline for where initial protective stops could be placed (from the entry)
based on the price of the stock. This should help to keep you from being
stopped out prematurely. Keep in mind that tighter stops can be used on less
volatile stocks. Conversely, more volatile stocks will require looser stops
Stock Price Protective
Stop (amount risked)
$10-$15 $1
$15-$20 $1-$1.50
$20-$30
$1.50-$2.00
$30-$50 $2.00
$50-$70 $2.50
$70-$100 $3.00
$100 $3-$4
Money Management
Initial Profit Taking
On most swing trades, the profits will
be small and have the potential to quickly erode. Therefore, as soon as your
profits (a) are equal to or greater than your initial risk (b), you should lock
in half of your profits and move your protective stop on your remaining shares
to breakeven (c) — (near your original entry).
Locking in half of your profits and
moving your stop to breakeven when your profits are greater than or equal to
your initial risk, will help to generate income for your account. This income
will help to pay for the inevitable small losses associated with swing trading.
Further, barring overnight gaps, this gives you, at worst, a breakeven trade and
a chance at a home run on the remaining position. Larry
Connors, in Connors On Advanced Trading, has dubbed this simple, yet
effective, form of money management 2-for-1 Money Management.
Keep in mind that this is just a basic money management system. You can
(and should) build from here. Also, conditions will help dictate where profits
should be taken. For instance, in strongly trending markets where the sector and
stock are also in gear, you might look to let profits ride a bit on the first
loaf after the profit target is hit (e.g. trail a stop intra-day on the first
half). Conversely, in choppy markets, you might look to take profits more
quickly and move you protective stop to breakeven.
Trailing Stops
Stops can be trailed higher on a point
or pattern basis. Using a point basis, one would simply follow the guidelines
outlined in the table on page XXXXX, provided of course, the volatility of the
stock is taken into consideration. For pattern based trailing stops, one could
place their stop beneath support levels or beneath recent lows. For instance,
placing a stop below a two-to-three bar low can often catch the majority of a
strongly trending market.
My goal with every swing trade is to
have it turn into a longer-term play. Therefore, if I am fortunate enough to
capture a short-term move in a stock and have already taken partial profits, I
will trail a somewhat looser stop on the remaining shares. Ideally, this will
allow the stock enough room to have and orderly correction (or form a base) and
then resume its uptrend. Each time a stock the stock does this, I then tighten
to the level of the last base/correction.
Good luck with your trading,
Dave Landry