Managing a trade is more important than entering in a trade. Here are two main tools for trading management: profit targets and stops. From these two simple tools, complexities explode because there are many choices—where do we put them initially? Do we move them? When and how much? Ever cancel them? Any other possibilities, such as a time stop? If we exit, do we ever add back? Do we consider other positions/correlation?
Before you trade, you should have a pretty solid answer to most of these questions. This is part of developing your trading plan. Let’s narrow the scope today and focus on trailing stops. These are stops that are moved as the trade develops. Knowing when and how to move them is a key part of trade management. Here are some ideas:
In general, when the trade moves in our favor, we want to move the stop to reduce open risk in the trade. Conversely, if the trade doesn’t move and just sits around our entry price, we can still move the stop. Move it enough, and you’re almost sure to get stopped out. This can be an effective alternative to a time stop (which is simply to exit if you don’t have a profit in N bars.)
We can use market structure, specifically previous pivot highs and lows, to locate stops.
Consider whether to put stops at, inside, or just outside of those previous pivots (which we can think might offer some support/resistance.) Most traders will default to outside the support/resistance, with the logic that they do not want to be stopped out of trades that are still valid.
Another possibility is to simply trail a stop at the lowest low of the past 2, 3, 4, or 5 days. (This only works in a strongly trending market.)
There are some technical indicators/tools, such as Parabolic SAR and Chandelier stops that can be used as trailing stops. Like everything else you use, you should understand the nuances of the tool before you bring it into your system.
Simply using the highest high or lowest low of the past N days gives you a market-structure based stop. (These are often called Donchian channels.) Choose your value of N depending on the type of entry you use and your intended holding period.
Moving averages are another possibility. Though they do not test out well in quantitative tests, they have the advantage of being a simple, clear level.
Having a plan is better than no plan. Does having a trailing stops improve your trading result than having no trailing stops. It depends on your system. You have to backtest and foroward test your system with and without trailing stop to find out how effective it is in your system.
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