I’ve written many times that there is no absolutely perfect money-management tool in trading markets, although purchasing options on futures does limit your risk of loss to the amount paid for the option.
Employing protective buy and sell stops in futures markets (a sell stop if you are going long and a buy stop if you are going short) is a must for most futures traders. Protective stops are not a perfect money-management tool, but they are very effective in helping to solve one of the most important elements of trading markets: When to exit a position. By employing protective stops and setting them in place as soon as you enter a trade, you will have a pretty good idea of where you will be getting out of the trade if it's a loser. Traders in the cash market can set “mental stops” but it’s important that you adhere to your original plan of action once you set those mental stops.
And if your trade becomes a winner and profits begin to accrue, you can employ "trailing stops," whereby you adjust your protective stop to help you lock in a profit should the market turn against your already-profitable trading position.
I’ve also discussed in past educational features where to place protective buy and sell stops. Usually, the placement of protective stops is near key technical support or resistance levels—just below support for protective sell stops, and just above resistance for protective buy stops.
However, there is one more method of using protective stops, and that is using “time” stops. This means giving a market a pre-determined amount of time to move in your favor--or you just exit the trading position if it does not. For example, if you are a position trader and decide to go long a market, you can give that market, say, four trading sessions to move in your favor. If, after four trading sessions, the market has not moved in your favor, you call your broker and exit the position the following trading session.
There are many veteran traders and educators who believe that if a market has not moved in a position trader’s favor after three or four trading sessions, then odds decrease that the market will move in the trader’s favor in the near term. I do agree with this trading tenet, and have effectively used “time stops” in the past. In fact, I plan on using “time stops” more in the future.
Shorter-term day traders can also employ "time" stops. Instead of determining the number of daily trading sessions for the "time" stop, the day trader can determine the number of price bars on an intra-day chart. For example, if the day trader has not seen a profit accrue on his trade after 12 bars on the five-minute bar chart, he may decide to exit the trade.
Traders can also use “time” stops along with the regular protective buy and sell stops that are placed near support or resistance levels just after the trade is executed.
It’s reassuring to a trader to see a market move in his favor soon after the trade is initiated. And if the market does not, or just “treads water” in a sideways pattern, the trader can exit the position at around break-even, or a small loss, and then move on to looking for other trading opportunities.
That's it for now. I enjoy receiving emails from my Kitco readers. If you have a comment or question, drop me an email. Next time, we'll focus on another important issue on your road to trading success.
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