1. Cost covering objective stop
For me, it is important that I cover costs. This single, simple idea has been one of the most important concepts of my success in the markets. I never allow myself the luxury of counting profits until I have covered my costs. As long as I take сarwе of that one detail, the profits seem to take care of themselves.
By covering costs, I mean taking care only of the immediate costs of the trade — **commissions and fees.
I do this in conjunction with market volatility. Volatility must be equal to at least twice my immediate costs or I will not trade. That means unless I have a chance to cover costs with no more than half my position, I will not trade. An exception to this rule would be if I were trading three contracts. Then I would want to be able to cover with one or two contracts.
Let's assume I want to get long a day trade in the S&P using a five minute chart, and that my costs are $25 per contract, and that I am going to do a three lot.
I would need $75 to cover costs. Since a single tick in the S&P is worth $25, I would need six ticks of average volatility in order to meet my rule of the volatility being twice my immediate costs.
Why twice my costs rather than some other multiple? Or why any multiple at all?
The reason for a multiple of two is the propensity for prices to overlap.
Take a look at what follows:
If I were looking for a breakout of the Rh, it's clear that a part of the momentum of the price action will be used up just in getting to the breakout point.
By using twice the volatility as the least amount of volatility with which I'm willing to enter a trade, I increase my chances of reaching my objective of covering my costs.
These stops, where possible, are placed as „market if touched“ (MIT) orders.
2. Small profit objective stop
Once I have covered costs, I try to take some sort of profit. Depending upon observable market action, I may take that profit at the same price at which I cover costs. Whenever possible, I attempt to take the profit at a better price than costs, but that is not always possible. How do I tell?
If a market has been moving strongly prior to my entry into a trade, especially if it has been trending well in a time frame that is longer than the one in which I'm trading, I will have resting MIT orders for only that number of contracts that enable me to cover costs. My first profit stop will be set at an amount which is dictated by average market volatility. For example, if I need six treks to cover my costs, and average market volatility is thirteen ticks, then I will have a resting, cost covering МIT, at six ticks and a resting, small profit MIT, six or seven ticks beyond my cost covering MIT stop.
The point of all this is to avoid s situation where I have no profit to show for my having taken the risk of market entry.
3. Full profit objective stop.
My third objective is to capture as much of the move as the market will allow. This is done with a trailing stop. In other words, my objective is to be stopped out. There are two considerations here.
A. Until I am satisfied in my own mind that the market is now trending, or is going to trend strongly, I will trail a 50% stop. When I am convinced I am in a strong trend, then I can do a number of things which will be covered in the next section under trailing stops.
B. When I am satisfied that I've made a nice profit, and feel there is no way I can be terribly hurt, I will lift my 50% trailing stop in favor of giving the market all the room I am comfortable in allowing.
