Trading 101 says "ALWAYS place a stop". So you follow that rule and three trades later you have been stopped out on every position losing a total of 30 pips.

Well, silly trader. Your stops were too tight. I can guarantee that a 10 pip stop will be hit in close to 100% of your trades. So what is the right level?

A simple answer is: A stop should be 10-20 pips beyond the level that determined why you entered the trade. For example, if you entered a long trade because price exceeded yesterday's high, then set your stop at 10-20 pips below yesterdays high.

There is a problem with the whipsaw effect though. To illustrate lets take a look at the following GBP/USD hourly chart. I want to take the short trade at the closing price of 1.4878. There are a host of good reasons for this trade but the primary trigger is that price closed below the 62 EMA (Blue colored line). I want a target of 100 pips and I would place a stop at 1.4935 which is 23 pips beyond my trigger, the 62 EMA. This follows the simple stop rule. [side note: This setup is for illustration purposes only. Don't use a similar setup for an actual trade. Play along with me though and you will see the point!]

The next chart shows the whipsaw that stops the trade out. At that first stop it is easy to believe that the previous uptrend is going to be continued. This would mean that price would continue to rise after hitting the stop.But in fact, price returns downward with a candle closing again below the 62 EMA. So I enter a short trade again at 1.4894. I set the stop at 1.4935 (same as last time) and my target is now 116 pips.

Oops! I get stopped again. Two trades, two stops, and I am down 96 pips. I must be an idiot to have believed that price was going down. Obviously price is going to return to the uptrend as it won't break through some support level around 1.4865. So I should reverse and ride the trend up and up!

That would be a silly move as the next chart shows. Price in fact makes my initial target and with 20 or so pips beyond before encountering any support. So where was the error? Did I just enter too soon? Were my stops too close? And if that's the case how big should my stops be?

The answer is that the stop was at the wrong level. The right level is illustrated in the third chart. It is above the Pivot point. The Pivot point (shown as a dashed magenta line) works as a protective barrier far better than the 62 EMA. But if you regard the 62 EMA as the first barrier, then the stop is placed two barriers beyond entry price. Under this scenario, the first trade could be held to completion. If a 83 pip stop is too steep, then entering the trade at either circled point would yield a more modest stop and a very profitable target.

The new stop rule: Set your stop 10-20 pips behind a protective barrier a level deeper than your entry trigger.

The next question that should jump out is "What are protective barriers?" Any price level that acts as support or resistance is a protective barrier. I don't want to over use the term "barrier" but it is an illustrative term. But to get back to standard terminology, we are talking about support and resistance. The support and resistance levels (SR levels) I use are the 62 EMA, the 248 EMA, the 800 MA, the Pivot points (Pivot, S1, S2, R1, R2), Fibonacci levels from the most recent trend of at least one day, and the previous day's high or low. For stops and targets, the ones I use the most and in order of significance are Pivot Points, 62 EMA, and Fibonacci levels. Any time two or more SR levels are close together or equivalent, I regard that level to be especially strong.

There is much more to be said about stops, but we will have Part 2 in a later post.

Published in 1866, Robert Louis Stevenson's novella The Strange Case of Dr. Jekyll and Mr. Hyde was a masterpiece that dealt with the duality of our natural selves being both good and evil. For millennia philosophers, religious leaders, and thinkers of all political, national, educational and theological stripes have debated whether man is inherently good or evil or, as Mr. Stevenson put forth, both. I would contend that we are both, and it is the struggle to overcome the evil that defines our existence. It is the hope, indeed the promise that we can overcome evil, that makes life worthwhile. Indeed, it is the love reflected in a child's face and the bright faith in a better future for that child that define the pinnacle of joy for most of humanity.

But I digress.

This is a blog about trading good and trading evil. I confess to succumbing to trading evil. The trading week ended May 1 (2 weeks past) was entirely dominated by my Mr. Hyde trading persona.

My children call this persona Chuck. Chuck is the person that yells at them to do unreasonable things. Chuck is the person that is irrational, angry, rude, and otherwise evil. Daddy, however is loving, cheerful, generous, and a joy to be around.

In trading, Chuck is brash, self-conceited, over-confident, fixated on a particular outcome despite all evidence to the contrary, and completely beyond reason. Once Chuck is in control of trading, no amount of risk is too great. He becomes certain that price is going to a certain level and any opposing movement is just an unexpected pull back that will come around to his determination of the future. At a point Chuck will become desperate and compound his investment by doubling down. He will move from a reasoned position to a maniacal losing position and short of outside intervention, nothing can prevent him from a disastrous result.

In my case, there are warning signs of the emergence of Chuck. I am of the firm hope that Chuck can be contained, controlled, and even banished by several key steps.

First, recognize that Chuck exists and will always be lurking in the shadows. Such an acknowledgment keeps one humble and in the proper defensive frame of mind.

Second, allow someone close to you to monitor your trades and trading progress. This person can step in and cut Chuck off at the knees before too much damage is done.

Third, never enter a trade unless you know these three things:

1. Why you are entering the trade
2. What is the profit target
3. What is the stop price

Fourth, request (or insist) that the person close to you ask you for those three things. That person can intervene if the answers are not certain.

I will elaborate on stops and how to use them in a subsequent post.

+210 Pips +21.1% growth 10 Trades 80.0% Wins