Protective Stops

It is very difficult to tell someone just where to place stops. This is because stop placement is a function of a number of variables. The size of the account must certainly dictate stop placement. The ability to withstand pain (comfort level) is a major factor. It's not practical to tell another person to place stops at a certain percentage away from the entry. That doesn't make sense. If the stops are too close, there will be losses on what might have been winning trades. If the stops are too far away, there will be larger losses on losing trades than were necessary.

Telling someone to place his stops at a certain number of points away from entry is also impractical because account sizes vary as do individual levels of comfort.

Traders should be highly suspicious of someone who presumes to tell them where to place their stops, unless they are following a person's trades on an advisory basis. Then, of course, they must use that person's stops or they wouldn't truly be following what they've paid to find out.

Since I will not presume to tell anyone where to place their stops, let me tell where I place mine.

When I enter a daytrade I use a mental stop. Mental stops can be dangerous. You must follow your discipline and stick with your stop price. When I trade I use a mental stop exit on one of two conditions:

• If I see two reversal bars in a series of price bars that are moving in the desired direction away from my entry point.

2nd reversal bar. Bar 'closes lower than it opens.

1st reversal bar. Bar closes lower than it opens.

Exit on 2nd reversal bar when trading method.

with the violation

1st reversal. Bar closes higher than it opened.

2nd reversal. Bar closes higher than it opened.

Exit on 2nd reversal bar when trading with the violation method.

Exit on bar that makes a lower low in an up move

Exit on bar that makes a .higher high in a down move

• If I see a bar that makes a lower low in an up move, or a price bar that makes a higher high in a down move.

These exits are all part of the violation method.

This method of handling stops is valid for both intraday and position trading, so I'd better illustrate the point. I call this technique the "violation method."

It is assumed that in an up move, prices will move in such a way that each price bar will close higher than it opens. Overwhelmingly, on a percentage basis, if in a series of price bars in an up move you see two bars which close lower than they open, the indications are that the move is at least temporarily over. I take my money and run. I can almost always get back in when the move resumes. The two bars in the series do not have to be consecutive. Any two bars in the series will do. The combination of open-high/close-low price action in an up move is called a reversal bar.

Conversely, in a down move, it is assumed that prices will continuously close lower than they open. When I see any two bars that reverse this process (i.e., open low/close high) I have two reversal bars. I exit immediately. The reversal bars do not have to be consecutive, they can occur anywhere in the series.

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