Essential trade management techniques for the smart trader

25 June 2016, 20:53
Sherif Hasan

To achieve consistency, you will need to be able to adapt to changes in the market after you get into the trade. Holding on and hoping to hit your target is far from the best strategy....

Having a low risk/ high reward entry is all well and good, but unless you are equipped to handle any number of eventualities, your results will never quite reach the levels you know they could.

Here are some trade management techniques that we use in our signal program (and I use in my personal trading) to achieve consistency. As you can see from the results, these trade management techniques are quite effective.

Note: Not all trade management rules in this article should be used for every trader. Rather it is a collection of techniques so you can pick and choose the ones that fit your approach and personality.

Remember if it does not have a meaningful impact on your plan it should not be used.

Implementation plan

The way you implement your trade is directly related to how you manage your trade.

For example, you may enter 50% at market with a wide stop, and then the other 50% on a limit. Once the limit is triggered, you may choose to take part or all of the limit off once it gets back near your original entry.

Conversely you may decide to go all in at market with a tight stop. Obviously this changes the way you manage the trade.

When you implement your trade, you should consider the following things.

  • Entry methods

    • 100% at market

    • 50% at market and 50% on a limit

    • Limit only

    • Stop only

  • Stop-loss placement (tight or wide)

  • Targets (Single or multiple)

  • Position size

To learn more about these, please see the Advanced Forex Course for Smart Traders.

Breaking your position into parts

Effective trade management may require you break your trade into several parts. That is, you scale out of your position, and perhaps even re-enter parts you have taken off.

To keep it simple, I like to scale out in three parts. Each of these parts has different objectives.

  • Fast position. This can come off early in the move to lock in some profits. This serves to reduce the size of any losses and smooth out the entry curve. This is "taking some profit when the market makes it available".

  • Slow position. I will generally hold this position until the target, or will exit on a price action reversal. Once the fast position has been exited, I will also move some of the slow position over to replace it, if we get a fast market type.

  • Core position. I hold the core position until the final target is met, or my wide trailing stop is triggered.

You need to decide if scaling out is right for your approach - it's not going to be for everyone. You need to balance the simplicity of a single exit with the benefits of a more complex scale-out approach.

Targets to improve consistency

I advise setting three targets for your trade. By having multiple exit orders in the market you have more chances to take profit. Simple but effective.

  • One target should be close to your entry price

  • The second target should be at your "real target" about 2-3R away (3 x times your risk) and based on a key level where the price is likely to reverse

  • Finally, employ a distant target for big wins. For longer-term trading this could be a key level at least 10% away from the current price, or for short-term trading it could be a multiday day move.

At each target you could exit your fast, slow and core positions respectively. Or you could close 1/3 of your trade and split the remainder of your position into three parts.

If there are no clear places to put targets, you might instead decide to let your profits run based on the trade management rules below, or a combination of both.

Otherwise, it may depend on your set-up. I will let low volatility break-outs run with only a final target. For other set-ups I find targets are quite important.

Look at the market with open eyes and make good logical decisions when you plan each trade and stick to them.

Reversal right after entry

Sometimes, despite a well-conceived trade, the price action just does not follow through. If this happens, it's time to protect our capital and abort.

I like to use candlestick patterns for this purpose. Here is a hammer that occurs right after entry.

Here is a hammer:

Here is a morning star:

In order to avoid exiting erroneously on a reversal right after entry, make sure that the candle pattern is obvious, and occurs in the first two days after you place the trade only (unless it is a three-day candlestick pattern).

Tighten stop and cancel limit

Firstly, I am not a great fan of breakeven stops. Using a breakeven stop often means your stop-loss gets put in a place that is easy to hit.

In saying that, Steve and Alan will use breakeven stops to good effect in our signals. My preference instead is to move the stop to 0.25% behind the entry candle (or two candles if the entry candle is small).

I will do this once the price has clearly broken out into a trend, and at the same time I will cancel any limit order that has not been triggered. This serves to protect my trade from a sudden reversal, while avoiding being stopped out of a winner by trailing my stop too tight.

Building a position

If my limit order is not triggered, I will then look to add the remaining part of the trade as the price goes for me. This allows me to get to my full size, even if my limit was not triggered.

This improves consistency, as I can benefit from both trades that go quickly in my favour, as well as trades that chop around above the entry for a while.

I will add on the first candle that closes in clear space in the direction of the trend once the price has moved away from the entry by 0.5%.

Sometimes I will scale in aggressively: specifically, on breakout trades from low volatility set-ups .

Note that if the market is oversold or overbought as indicated by the RSI, and there is a long candle (greater than 1.25%), I will not scale-in.

This ensures I follow the good sense principle of not entering when the move is already done and there is a high chance of a reversal.

Note that this does not apply to the initial entry (on long-term trades), as you want the first move in the direction of your trade to be strong.

Optimizing scale-in entries

On a micro level, it can make sense to use OCO (one-cancels-other) orders to get a better price for your scale-in.

For example, if I am scaling in short, I will set a stop sell on the low, and a sell limit where I expect the price might bounce too. The first one that gets triggered cancels the other one. This has saved my skin several times.

Just think; "what is the best way to implement this scale-in opportunity".

Using this subtle technique means that on occasion I end up with a better entry, while ensuring I don't miss out on a strong trend - it pays to remember that moves don't happen in straight lines!

Time stop

While it is not something that I tend to use, some strategies certainly can benefit from exiting at a certain time if conditions have not been met.

For example, if you have a day trading strategy that enters during the London Open, you may want to close out of your trade at the end of the session if a target has not been met.

Fast market type exit

One of my most highly recommended trade management techniques is a fast market type exit.

Once the price moves rapidly in one direction, it has a habit of reversing rapidly in the other. This leaves traders who thought they were sitting on a healthy profit scratching their heads.

To counteract this phenomenon, I will exit 1/3 of my trade in a fast market type at the first sign of a reversal.

I do this by waiting for either a reversal candle, or for the price to close back inside the Bollinger Bands. Instead of exiting at market, I prefer to trail my stop to 0.1% behind the low of the candle.

There are plenty of other ways you can exit during fast market types. The key is to take some quickly before it reverses.

Scale-out on strength

An alternative method that can help smooth the equity curve is to take some profit on the first sign of strength.

If you are in a trade and the market gives you a windfall profit, then grab it (I use a 1.5% or greater gain in a day for this rule).

This approach lets you capitalize some of your gains immediately. It may partly cut you out of some trends early, but it will also ensure you don't turn a solid winner into a loser and it will improve the consistency of your trading.

You may choose to spit your fast position between this and the fast market type stop described above if it is not too complex for you.

Volatile news event

News events often act as the catalyst in both driving and reversing trends.

The good thing is that most of the time you will know the potential impact of a given event in advance, so you can plan appropriately.

In general, early in the trend I will keep my stops wide in order to let the trend eventuate. But later in a trend, if I have a decent amount of profit, I will be aggressive in protecting it.

I have learned in the school of hard knocks how much an overbought or oversold market can give back on news it does not like. Profit taking kicks in, liquidity dries up, and momentum traders jump on-board erasing hard earned gains in a flash.

To protect the position, I will tighten the stop on some or all of the remaining position, rather than exit at market.

Technical reversal signal

Sometimes the market gives us a nice clear sign that the odds of reaching our target have dramatically reduced. When it does, be prepared to act rather than hold on and hope.

Here you can see clear signs that we may be topping out on EURJPY.

It's important to note that if you do want really big winning trades, you are going to need to hold on through these periods of indecision.

I will close one third of my position if I see this type of price action, while leaving the remainder on a wide trailing stop.

Trailing stop for big winners and trends

To really grow your account, it can be helpful to have some big winning trades.

Part of the theory behind consistent trading and multiple exits, is that a trend following approach can be very profitable, but it is hard to trade as you can have lots of losses while you wait for the trend to break out.

By being comfortable with taking a little bit off the table when the market makes some available, you can greatly decrease the number of losses, and by leaving some skin in the game you can still benefit from the trends when they do come around. This is a less stressful way of catching trends, rather than having to sit through ten losing trades in a row before your winner comes along.

Key to this approach is making sure that when the trend does come along, you don't cut your trade short.

In order to do this a "mechanical" trailing stop is appropriate. I like to use the super-trend indicator for this this purpose:

But don't be fooled by one chart. These trends are far from a common occurrence. Here is what happened next:

As you can see, the life of a trend follower can be difficult without a way to remain profitable/limit losses in the inevitable consolidation phase.

I also like to use a trailing stop on my "slow" position, as I don't want to give back so much on that. For this, I use the 3 and 7 period exponential moving averages. Again, rather than exit on the cross, I will tighten the stop to 0.1% behind the candle.

In particular, I like to use it after "strong" market types when there is no price action reversal.

Note that I won't use the 3x7 until after a trend has broken out. If the price chops around near the entry, then it won't kick in.

Price gets close to your target and falls away

The next trade management technique is designed to eliminate those horrible situations when the price gets close to your target and then falls away.

Firstly, it is important to note that even though I am a long-term trend follower, I do like to use targets. While on occasion this means I don't benefit from the full trend, more often than not it helps me to avoid giving back a decent chunk of profits. Generally, I look to place the target around 10% away, but I will adjust this depending on the charts.

If the price does get within 1% of my target, I will start to dramatically tighten the stop. I use a method called 1:1 risk/reward stop. So if the price gets to within 1%, I tighten the stop to be within 1%. If it gets within 0.5% I tighten to 0.5% and then finally, if it gets to within 0.25%, I tighten my stop to be within 0.25% of the current market price.

By doing this, I don't have to hit my target to be profitable, I only need to get close. We also employ this method to very good effect on the short-term signals.

Re-entry method/adding to trending markets

Once you take profit, or if a trend continues in your favour, you may want to continue to add to the position.

I do this in one of three ways, though I find my favourite of the three is the breakout method.

  • After periods of consolidation on daily charts (or low volume breakouts on 4 hour charts) in the direction of the trend, I will look to either add a new position, or re-add a position I have taken off - depending on how I am placed at the time.

  • If a busted breakout occurs in a trend, I will add to the position.

I will also add on a cross of the 3x7 moving average in the direction of the trend, as long as the RSI is not oversold (bearish) or overbought (bullish).

The benefit of using RSI combined with the moving averages is that it eliminates discretion from the approach, reducing errors.

Blow off top/bottom + Extreme market types

Sometimes it makes sense to grab your gains and run.

Market type analysis suggests that trends finish in "blow-off tops and bottoms". That is, one last aggressive move before capitulation.

In these circumstances, or at other times when you are granted windfall profits, it's best to take them.

To do so, move your stop-loss on the entire position to trail 1% behind the current price.

You can tell when it is time to do this by a very long candle (or series of candles, ending in a very long candle) that is trading outside the Bollinger Bands, or if the price moves over 2.5% in a day after a strong trend. The RSI will also be reading at extreme levels:

If you are using profit targets, more often than not these moves will take you out anyway, but if you do have any left on, you want to be proactive as it is quite likely the price will reverse quickly.

Three tips for successful trade management

The first trick to managing the trade successfully is to have extreme clarity in your rules. If you have ambiguity, you will make inconsistent decisions, which lead to inconsistent results. Be precise in your interpretation of each element of your technique.

The second trick is to keep it simple. As mentioned earlier, not all trade management techniques are going to be right for your approach. Pick and choose the ones that will yield the most fruit, and if a rule is adding complexity without a noticeable improvement in results, then shelve it.

Finally, don't forget the overarching principles of trade management. The idea is to help you find the balance between cutting your losses short, letting your profits run and taking profit when the market makes some available in order to achieve consistent results.

If you follow these three tips, then with practice, trade management is likely to become the core of your trading activities.

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