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In this part we will look at the application of risk management, starting with the use of an initial stop. The best technical analysis will not be successful without good money and risk management.
Besides making sure that you are applying a good money management system, you have to limit the risk with every trade once a buying order is executed by keeping an initial stop.
The initial stop itself is variable from trade to trade because it must be based on different technical analysis techniques. On the other hand, you must use a trailing stop as the ultimate warning signal to sell, avoiding losing too much profit.
This is the video:
This is the text:
Hallo, Sylvain Vervoort with technical analysis part 28. In this part we will look at the application of risk management, starting with the use of an initial stop. The best technical analysis will not be successful without good money and risk management. Pay a visit to my website at stocata dot org and buy my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system.
Besides making sure that you are applying a good money management system, you have to limit the risk with every trade once a buying order is executed by keeping an initial stop. The initial stop itself is variable from trade to trade because it must be based on different technical analysis techniques. On the other hand, you must use a trailing stop as the ultimate warning signal to sell, avoiding losing too much profit.
First we have a look at the initial stop. Trading on a daily chart, we should as a rule of thumb, limit the maximum loss to between 10 and 15% depending of the volatility of the stock. However the initial stop must be set using technical analysis rules. In this chart we want to open a long trade based on the fact that we may have completed an ABC correction wave, at the last low point we have a candlestick hammer pattern and with the next candle a bullish engulfing pattern. Price is breaking the short term downtrend line and finding support on a previous resistance, now probably becoming support. With a higher closing price the bullish engulfing pattern is confirmed. The SVAPO indicator is turning up from below the lower reference level. Certainly enough good reasons for opening a long position. But what about the initial stop? Technically we can use the low of the bullish engulfing pattern as the stop loss level. Meaning that you would now buy at $25.3 and if the closing price falls below $23.4, you will close the trade. That is a loss in the order of $2 or a loss of about 8%. So, you can open a trade here.
Apparently there were 3 more days that you could enter the position with the same initial stop setting. Next price made a bigger gap and now 3 days after the gap, jumping out of a downward wedge pattern, you could ask yourself if it is still possible to enter the trade not taking too much risk? Entering now at $27.3 and the stop still at the low of the bullish engulfing pattern at $23.4, would create a possible loss of about $3.0 or a los of about 12%. This is rather high. But you know that a gap or window is giving support. So, you can use the low of the gap at $25.3 as the initial stop now. This gives a possible loss of about $2 or about 7%. That makes entering a position here still a good decision.
Of course you want to know what came next. It was a nice profit. You would close the position noting that price was making only limited higher highs and higher bottoms while the SVAPO indicator was diverging with lower values. When next the last short term uptrend line was broken it was the signal to sell. SVAPO takes also into account volume and is moving up here because of higher average volume in the down move, which is a negative signal here.
Again here we have a bullish engulfing pattern, probably a complete ABC correction wave and the SVAPO indicator turning from a second bottom up. Is the initial stop OK? Buying now at $33.6 and a stop at the low of the bullish engulfing pattern at $31.2 gives a possible loss in the order of $2.4 or about 8%. This is acceptable and you open a new long trade.
Now you are saved by the initial stop, mostly preventing even bigger losses. There was apparently another correction extension completing one more zigzag pattern. There are no indications now that price is at another buying point. So, you better obey and close the position here with a loss. You never know how much further down price can go.
In this chart we have most probably reached a top with a wave 5 end of June. Since then we had a correction wave A and there is a good chance that correction wave B is also finished. Now the closing price is falling through the short term uptrend line and the SVAPO indicator is moving down with a negative divergence, a higher top in price and a lower top in SVAPO. This points in the direction of a downtrend reversal. Taking a short position now may bring nice future profits with a wave C down. What you still have to look at before taking this position is the initial stop value. At the B-wave turning point you see an evening star candle pattern. You can keep a stop at the top of this pattern. This means selling now at $35.8 with an initial stop at $37.3 or about $1.5 or less than 5%. So, there is no reason why you should not take this trade.
And as you can see a very big profit was made with a very limited risk at the start. That is of course the main idea behind the use of the initial stop.
Let's make some exercises. You can find the solution at my website at stocata.org/youtube/solutions.html. Assuming there are some good reasons here to open a long position, like breaking the downtrend line. But can you start the new position with an acceptable initial stop?
Here price made an up reaction after a downtrend. Price now breaks out of an up moving wedge. You want to open a short position. Can you start the position with an acceptable initial stop setting? You can find the solution at my website at stocata.org/youtube/solutions.html.
This is the end of the part about using an initial stop setting. Next video we will have a look at using trailing stops. Tell your friends about these videos and while visiting my website order my new book “Capturing Profit with Technical Analysis”, a complete technical analysis reference and a winning trading system. See you in the next video!
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