Successful trading is about helping yourself and putting the ‘odds’ on your side. In part 23 we looked at strategy, design and implementation. This week, we’re going to take a brief look at an often forgotten and overlooked use of technical analysis: Risk & Trade Management. If you are a raw fundamentalist, or don’t want to use technical analysis to make trading execution decisions, that’s fine, but I think you’re being foolish if you don’t consider using technical analysis to improve your risk & trade management processes.
As we’ve learnt over the previous 23 articles, technical analysis is great as it can:
- Make and save you money
- Save you lots of time
- Help you deal with the psychological aspects of trading
- Create discipline
- Be simple to understand and apply
We now know how technical analysis could help you with strategy design, but is is also a very strong tool to help you in the world of risk. It gives you a set of rules, ie. fixed and objective parameters around which to trade, which in turn, creates the psychological discipline you need in your trading.
Many people go into trading blind – no rules, plans, strategy and especially no risk & trade management concepts to deploy. That’s why so many lose at trading.
Money management & Risk reward
On top of developing a strategy with a mathematical edge, you also need to address money management – this is as important as your trading system. You can use technical analysis to control the risks in your portfolio and individual trades. For example, you can use moving averages or an oscillator as a tool to get you ‘automatically’ out of a losing trade. This takes away a lot of the psychological pressure of trading. You can also use technical analysis tools to calculate the risk reward on any potential trade idea you have:
- Is it worth executing a trade?
- Only if the risk reward is in your favour. How do you calculate?
- The risk/reward inputs can be defined much more simply and clearly by using technical analysis.
- A risk reward > 2:1 is very good. Mathematically you’d need an edge >50% to your strategy if your ratio was 1:1.
From the example you can see that technical analysis can help define the inputs:
Lets take a look at a real world example: Bitcoin USD (Charts: Trading View)
In the Bitcoin example, I have used Fibonacci to define key areas of support and resistance. If we were going long, where could we put our stop? Based purely on Fibonacci and as a very crude example, areas around 2900 and 2500 look sensible, depending on your trading time frames and knowledge of the asset’s underlying volatility. What other technical analysis tools could you use to define trade management risk levels? ATR (Average True Range), Pivots, Moving Averages or Volume at Price to name but a few! What is important for success though is that you adopt a consistent methodology.
Risk & Trade Management: Trailing stops
You’re in a trade. Don’t close it – trail it! How?
A lot of traders have fixed profit exits in their head or set in a system as a limit order. When they take their profit and close out their trade for example, they continue to watch the charts only to see the trade continue even further in the direction they were trading – much to their annoyance. How can you get around this? Trailing your stops instead of taking your profit like we just saw. This approach is psychologically harder to employ, but can lead to better results. You have to be prepared, though, to factor in giving up some potential gains now for ‘possible’ future profits! How do you do it? Again, by using technical tools and having a very well defined trade management plan that is executed consistently.
Let’s look again at our earlier Gold example. This time, instead of using a fixed target of $1500, we are going to trail up the stop. Imagine that the horizontal lines are Fibonacci lines and you move your stop to just below these levels, as the price makes its way further and further up, to be finally taken out around $1700 for nearly $200 extra profit. The tools you can use are very broad: Pivots (eg. for intraday trading), moving averages, parabolic SaR, Fibonacci and trend lines.
In my opinion, using technical analysis for your risk & trade management when trading and investing, is a no-brainer. Quite simply, it’s going to keep the shirt on your back. It is also going to remove a lot of the psychological aspects of trading that can be so damaging. Technical analysis is just great for: forecasting or targeting objectives, timing the entry & exit of a trade, trade sizing and calculating the risk-reward of trades. There are many technical analysis tools available to suit all styles of trader and investor. However, once you have found your tools of choice and defined your trading plan, you must act on it and execute it consistently. There are very fine margins between success and failure!
Further reading and learning:
If you are interested in learning more about how you can maximise risk & trade management techniques using technical analysis, please contact us at THE STOP HUNTER. We offer bespoke training solutions, as well as classroom based courses. Stephen Hoad (Trader & CEO) is one of the UK’s leading technical analysts, specialising in Japanese charting methods and systematic trading systems. He is also a lecturer for the Society of Technical Analysts (STA) in the UK.
Next time: Technical Analysis (Part 25): Putting it all together: Improving your results