Hello traders! This week I’d like to address a common problem that new traders who come to class often have. I was recently teaching one of our three day Market Timing Classes, where potential new students are introduced to Online Trading Academy and we decide if we are a mutually good fit, and this topic came up.
Actually, this topic comes up in nearly every class! In fact, it may be a problem that you have dealt with in the past. What is this common problem, you ask? Getting stopped out, then having the chart go almost exactly where you thought it would, even in the same time that you thought it would! Does this sound familiar to anyone out there? I know it was a frustration for me when I first started trading, and also whenever I added a new asset class to my trading plan! I began trading in 1997 with all of the SOES (Small Order Execution System) day traders out there, trading stocks in Dallas. Then I started trading spot forex in 2002, then the futures markets in about 2010.
Being a short term stock trader back then, I looked at the market much differently than I do now. Back then a stop loss was more or less just a “panic button,” taking me out of a trade if things went the wrong way. When you were expected to place a couple hundred trades a day, those trades didn’t have a lot of time to develop! Book the spread and move on. When I started trading the spot forex market I tried to trade it in almost the same frenetic style that I had used in stocks, but quickly realized I was doing it wrong!
Because the spot market is a de-centralized market where there is no place where all quotes and trades are reported, each broker will have slightly different charts and spreads to display to their clients. The way I look at this market, you have to give your stop loss a little extra “wiggle” room in spot forex than in other markets. This room might be as little as 2-5 pips MORE than what you thought your stop should have been ordinarily. If you have the problem of getting stopped out as described earlier, go back and look at the last couple of dozen trades where this happened; would an extra few pips of room kept you in those trades? Also, be aware of your reward to risk ratio if you choose to make your stop larger! If, by adding 5 pips to your stop loss your reward to risk ratio turns into merely a one to one, (or worse!) don’t add in the room. We recommend traders look for trades that offer at least a 3:1 reward to risk ratio. When trading from larger time frames, adding a small handful of pips to your stop shouldn’t affect your 3:1 reward to risk ratio very much.
If that quick fix didn’t solve your stop out problem then I’m afraid you have an even bigger problem on your hands. The problem is probably that you are looking at the wrong part of the chart. Many potential students looking to improve their performance come to us with the knowledge of “support and resistance.” If support and resistance were so good, why isn’t everyone making money using it? I’ll let you list the hundred or so reasons you could choose from, but in my mind the reason is obvious, your entry points are no good which is why you get stopped out a lot. We use supply and demand instead, which shows us where we believe institutions have leftover orders waiting to get filled. We seem to have more success than the old support and resistance traders.
In the following chart a “support” line was drawn off of a level where priced had moved up twice – hence the numbers 1 and 2. At the blue arrow on the same line a few candles later, you can see that price went straight through that support line stopping out anyone who had tried to buy on that line the third time it was there. How’s that working for ya?
At the blue arrow inside the yellow box, as price came back to touch the demand zone from the previous day, you actually had 2 quick chances to enter the long trade. Notice the difference between support and demand?
So there you have it! If you are getting repeatedly stopped out it could be one of these two reasons: your entry points are good but the stop just needs to be widened a bit, or your entry points are no good and you should stop using the same old methods that have proven to be unsuccessful for millions of traders before you. Until next time,