Archive for ‘average true range’

E-Mini Trading: Do Your Stop/Loss Points Get You in Over Your Head?

By , 16 September, 2011, 1 Comment

There is a tendency among traders, both new and experienced, to overestimate their predictive abilities as they relate to e-mini futures contracts. Over trading and trading too many contracts are common characteristics of the hard charging e-mini trader; but their exuberance might be put to better use if they held off a few years and gained some valuable experience to match their aggressive trading style.

In any event, it is imperative to always trade with your stop/loss limit defined and in place. I have known many e-mini traders who managed their stops mentally, without even an emergency stop, and eventually they encounter a disastrous result via a spike in the price action.  Always trade with stops in place; enough said.

But how do we set stops that are wide enough to allow a trade to develop, but narrow enough to fall within individual risk parameters.  If you run your stops too tight, you will find yourself stopped out of trades by ordinary market noise.  Too wide, and your losses can be staggering.  There are other factors when considering your stop losses targets, too:

•    Individual appetite for risk, ranging from aggressive to conservative (I recommend a conservative approach to trading.)
•    Market conditions at time of trading
•    Price positioning at time of e-mini trading decision
•    Size of traders account can sometimes dictate a certain trading style

I find myself favoring the use of the Average True Range (ATR) when considering the length of my stop/loss points.  Depending upon which author/system to which you subscribe, the suggested stop/loss is expressed as a % on the ATR; and the percentages range from 50% to 150% of the current ATR.  Though the numeric value of the ATR is an average of a pre-selected time period, they mustn’t be construed as predictive in the sense that they have an incredible sense of accuracy.  What we can glean from the ATR is that over the last, say, 14 time periods the market has average x and if things stay roughly the same, this is the kind of price range you can expect on a 3 minute bar, or whatever time period you have chosen.

So, we have learned that the ATR can give us an idea of what kind of price range/bar we have been experiencing, and barring any knowledge to the contrary, we base our stops on the ATR.
I like to use at least a 1:1 ratio on my ATR-set stops, and that may be a bit wide for some tastes, but I am a vocal proponent of using wide stops, as opposed to tight stops.  With our ATR number in mind, we now have a general idea where the price may move in the next 3-4 bars.  It’s a great technique, but don’t forget to keep an eye on support/resistance lines, fibgrid lines, and important Fibonacci lines when eyeing a trade.  Can you safely execute your trade while staying within the general parameters of support/resistance?

In summary, I have tried to make the point that stop/loss targets should be given consideration.  Too tight, and you find yourself stopped out of a trade on simple market noise; too wide and you expose yourself to excessive risk.  The key is to find that happy medium each day where you can handle a retracement without getting stopped out, and let your trade run when possible.  Great luck trading.

E-mini Trading Question from Individual: Understanding Risk in Day Trading

By , 10 September, 2011, No Comment

Hi David,

Hello, hope your well, quick questions on your ES trading, may I ask how big are your stops? And are your targets? do you use range bars? what times do you trade? what is your max loss ofr a single day?All this will help me determine if it fits my risk profile:) thanks!!

Paul  (spelling and sentence construction unchanged)

I wrote back this portion regarding the risk and stop placement in my response:

Hello Paul,

I have been an institutional trader, in various capacities, for nearly 30 years, most on the NYSE, the latter years in trading rooms for a the same investment bank.  Were it me, I avoid trading the ES at all costs.  I think there are much more profitable contracts to trade than the ES where there is less professional, institutional, and computerized trading activity. I am fond of the YM, 6E, NQ, and the ten year treasury.

Stops are sometimes calculated on the ES (or any contract) by using the Average True Range, obviously if the average true range is 12+ (which it has on most days of the week), it means that the previous bars have a range of 12 ticks, it really doesn’t make any sense to enter a trade with a 5 point stop, or an 8 point stop.  Random noise in each bar (or the level of random noise) will increase your losing percentage/trade.

But let’s talk about that silly notion of risk as it relates to trading, as it is very difficult to quantify in futures trades.  For example, assuming your favorite trade profits more than it loses; risk is usually defined as stop-loss/profit target.  So the average guy would tack a 10 tick profit target with a 10 tick stop loss and think he has flattened his risk some.

On the other hand, I set an 8 point profit and 25 point stop/loss, very unbalanced and carrying a higher degree of risk than your trade.  Right?  Let’s assume an average true range of 10; mathematically I have a 30% better chance of succeeding than you.  I had a student challenge me on this, so for one week I trade the 8-25 and he traded the 10-10.  We both traded 6-8 trades a day for 5 YM contracts.  By Thurs of the week, I was up more than a $1000 he asked to be excused from the trade, which I did.

The point is simple matter of mathematics; there are too many variables in every trade to fully understand the probability, in the exact sense, of the market doing this or that.  However, when you try to control just one variable you can increase you probability significantly.  In the above example, which is a more likely event?  Will I hit my profit target of 8 or stop loss of 25?  In pure mathematical terms I have a 79% chance of hitting the 8 tick stop and a 21% chance of hitting my 25 tick stop loss.  I initially chose 10 as your profit target and 8 as my profit target, because there is a significant difference in the probability of moving 8 ticks and 10 ticks.  Just think about the math behind what I am describing and quite possibly you will rethink your understanding of risk.  Risk, in a pure sense, is based on probability and probability in, in most ways, a non-linear component.  You might refer to some of Murphy’s books, as he has done some nice work in this area, though I disagree with him in a host of other areas.

Of course, there are many other factors you could try to control.  For example, supply/demand in the actual contracts offered is an interesting area of study.  Zero sum games can have convoluted outcomes in trading when a move to the long side simply runs out of supply, in other words, there are no sellers left to supply the buyers.

In short, I usually place emergency stops at 25,  and logical exit within my own loss parameters will be my mental stop.  Don’t ever trade without a stop-loss and contract count potential loss that is more than, say, 5% of your account.  But for sake of argument, maybe I could get your to rethink your understanding of risk as a function of probability rather than a straight 1:1 linear relationship, which has always been the traditional line of thinking.

Finally, I think that you may have a certain risk profile…but when you enter the market, our risk becomes the same.  So the game comes down to picking the right set-ups, at the right time (usually with the trend), and style. Those are the variables you can control, along with some lesser variables.  I held your view of risk for many years, on a much larger scale, of course, and have only started to consider risk in the last ten years.  Come visit my room and watch me trade.  I win a lot, and work hard at managing the downside on my trades.

ES Emini Day Trading: When to Exit a Trade Using Average True Range Indicator

By , 15 November, 2009, 2 Comments

When do you exit a futures trade?  Day trading related literature is chocked full of trade setups, but the advice on trade exits is very general, almost non-specific.  Ironically, I find proper exits more challenging than entries when trading the ES emini.

When do you cut your losses?  When do you trade out of a winning position ES Emini position?

From the onset, let me say that I often trade a simple 12 tick bracket on my positions.  This strategy is a good one for general trading, and I don’t know that you can go wrong with it, if you understand that you don’t have to stop or limit out to exit a position.  That is to say, if you are clearly on the wrong side of a trade, and your indicators indicate the price action is in the opposite side of your position, why not exit?  Save yourself some money.

So we have established that you do not have to stop out or limit out in order to exit a position, is there a great way to know how much to let a trade run, both for a profit or a loss?

There is an indicator called the average true range that I have found most helpful.  This indicator has been used for a variety of purposes in trading over the years.  Some of the uses have included entry timing, exit timing, and the indicator wasn’t always effective.  So it has received a some bad press.

Average True Range is just one of the wonderful ideas in Wells Wilder’s “New Concepts in Technical Trading” The Average True Range is an exponential moving average, and gives a trader a good idea as to the volatility of the market.   I generally trade a preset multiple of fraction of the market.  The idea is simple, really.  I want to avoid getting stopped out by the market noise of the day, but still retain the chance of pocketing some great gains.

For example; lets say the Average True Indicator is 2 (using a 14 period time setting), and I was setting my stops at 2X the Average True Range,  my stop loss would be set at 4.   In very volatile markets I may decide to trade at .75 of true range, which is what I did last year during those volatile months mid-year.

Whether you bracket your trades or use the Average True Range Indicator, it is important to have a sound exit strategy.  A well-thought out strategy, not a strategy that the market dictates.  Your exit strategy is in your control.

Oh, and never let a winning trade become a losing trade.

ES Emini Trading: Trade the Closing Price

By , 31 August, 2009, No Comment

Today’s chart, which should be directly below this post, illustrates something that I have a strong belief. I don’t know that my view is controversial, but as I watch people trade, not many are able to adhere to this simple principle: You are only interested in opening and closing prices in the time period you are trading.

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