Money and Risk management Part 3

Risk Management

Once a buying order is executed, you must limit the risk by keeping an initial stop. The initial stop itself is variable from trade to trade because it will be based on different technical analysis techniques.

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On the other hand, you must use a trailing stop as the ultimate selling signal to avoid losing too much profit.

And, of course, you must apply the money-management technique as explained in the previous paragraph.

Initial Stop

AdvancedStop.dll is an external DLL file that is available free of charge thanks to Richard Dale http://www.premiumdata.net

This external DLL file allows the fixing of a result until it is reset (flip-flop function).
We use this external DLL file function in the next formula for the graphical representation of an initial and trailing stop. 

At the time of this writing, this free DLL file was available at http://www.tradernexus.com/advancedstop/advancedstop.html

The following MetaStock® formula “SVE_Stop_Trail%_Date” creates an initial and percentage trailing stop on the price chart from an entry date:

{SVE_Stop_Trail%_Date - Fixed percentage trailing stop from date}
InpMonth:=Input("Month",1,12,1);
InpDay:=Input("Day",1,31,1);
InpYear:=Input("Year",1800,2050,2009);
LongShort:=Input("1=Long or 2=Short? ",1,2,1);
InitStop:=Input("Initial Stop Price",0.1,10000,10);
Perc:=Input("Trailing Stop Percentage",1,30,12);
Loss:=C*Perc/100;
Entry:= InpYear=Year() AND InpMonth=Month() AND InpDay=DayOfMonth();
StopLong:=ExtFml( "AdvancedStop.StopLong", Entry,InitStop,0,C-Loss,0,0,0,0);
StopShort:=ExtFml("AdvancedStop.StopShort",Entry,InitStop,0,C+Loss,0,0,0,0);
Trail:=If(LongShort=1,Stoplong,Stopshort);
Trail

Initial Stop Application

Let’s assume we bought the stock in figure 10.4 on January 6, 2003, based on the fact that the closing price was breaking the downtrend line.

Figure 10.4: Buying the stock on January 6, 2003.

With an initial stop at $6.1, we are at the support of a previously low pivot point. With a closing price below this stop, there is a good chance that the correction phase is not finished and that it will be better to close the trade with a loss. This stop gives a possible 13% loss and keeps the trade more or less within the limits of an acceptable loss on a single trade.

 

 

 

 

 

 

 

 

 

 

 

 

Figure 10.5:    Entering the stop properties.

Opening the formula “SVE_Stop_Trail%_Date”, we enter the date (figure 10.5) in this trailing stop date function; we select 1 for a long position and we set an initial stop value of $6.1.

Finally we set the trailing stop at 7%, but we can change this value once the price begins moving in the right direction. We will close this long position at the latest when the closing price falls through the initial or trailing stop.

Figure 10.6: Stop broken right from the start.

Unfortunately, right from the buying moment, the price starts falling and passes the initial stop (figure 10.6). 

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When the closing price drops through the initial stop, the transaction is closed.

 

 

 

But, as you can see in figure 10.7, it is a consolation to know  that without this stop, this trade could have ended in catastrophe. That’s why keeping an initial stop is so important: to limit the loss after opening a position.

This initial stop is the last warning to sell! It is bad practice not to obey this last warning!

 

 

 

 

 

Figure 10.7: Disastrous trade without a proper stop.

Money & Risk management next -Previous -Part 1 -Part 2 -Part 3 -Part 4 -Part 5 -Part 6

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