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In this part we will look at the application of risk management, continuing with the use of trailing stops and starting with the fixed percentage trailing stop.
A trailing stop should be used as a last warning signal to close a trade when other technical or human signals fail, that way preventing losing profit. The very last warning is of course the initial stop.
We start the trailing stop methods with the fixed percentage trailing stop. Here we calculate the maximum allowed loss based on a fixed percentage of the closing price.
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Hallo, Sylvain Vervoort with technical analysis part 29. In this part we will look at the application of risk management, continuing with the use of trailing stops and starting with the fixed percentage trailing stop. Remember, 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.
A trailing stop should be used as a last warning signal to close a trade when other technical or human signals fail, that way preventing losing profit. The very last warning is of course the initial stop. We start the trailing stop methods with the fixed percentage trailing stop. Here we calculate the maximum allowed loss based on a fixed percentage of the closing price. Because this trailing stop method uses a fixed percentage, there is not much you can try for improving results. The only thing you could do is look at the past and look for each individual stock what was the best fitting percentage in a previous period and than apply an individual value for each stock. However I would advise not to deviate more than 3% of the common value to avoid too much optimization.
I will use this MetaStock formula to fix the starting date of the initial and trailing stop value. You can find this formula at stocata.org/metastock/formulas.html.
Applying this formula, it will ask you for the start date; this must be an existing date in the data set. It will ask if you want to follow-up a long or a short position. It asks for the dollar value of the required initial stop and finally the required trailing stop percentage.
In this chart we opened a new long position beginning of March when a last downtrend line was broken. We entered an initial stop price of $12 at the low of the last low point on March 6, 2009. We are opening a long position and we want to apply a 10% trailing stop value. As you can see this trailing stop nicely kept us in the trade until the end of October when the closing price is falling through the trailing stop.
In this chart note that we are using a much lower trailing stop value of 7%. It is clear that with less volatile stocks or during less volatile trading periods; the trailing stop can be adapted in your favor. I will give you next the formula that will help you to find the appropriate percentage for a certain stock during a certain period.
This is the formula that can be found at stocata.org/metastock/formulas.html. This is a percentage trailing stop formula, that switches from a long to a short or from short to a long position automatically, when the running trailing stop is broken. Changing the percentage will give you a good idea of which value gives you the required result on historical data. You would then use this percentage for future data.
In this example chart you see that using a trailing stop percentage of 7% for this stock is not good. There are too many breaks in the uptrend. This will over time probably create too many losing trades.
However using a 10% trailing stop looks a lot better and keeps you in the medium to longer term up moves. Now, let's apply this 10% trailing stop on the following period to see if the result remains as good.
And yes, it does look good. The 10% choice works fine during the whole of 2005 and 2006. It is good practice to verify the used value once or twice a year.
This is the end of the part about using a fixed percentage trailing stop. Next video we will have a look at an ATR trailing stop method. 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!
Risk Disclosure: Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing ones’ financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.
Hypothetical Performance Disclosure: Hypothetical performance results have many inherent limitations, some of which are described below. no representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. for example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.
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