How Successful Traders Manage Their Trades (Part 5)

07/10/2009 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

I came back for one more look at gold futures a few minutes before the release of the non-farm payroll numbers and got a pleasant surprise: I had nearly $5 in potential profits in the position and at this point, I employed a risk management strategy I call “making a lotto ticket.”

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I cancelled my stop loss order at 930.30 and entered a break-even stop order. Price should be far enough away from my entry price that the normal noise associated with the gold futures market shouldn't wash and rinse me out of my position. If the economic numbers came out and were positive for gold futures, price should be pushed quite a bit higher, maybe even as high as my profit target; but it should at least give me an opportunity to box in profits below higher swing lows if price stair stepped higher after the number.

When the economic number came out, I had now reduced my risk to the loss of commissions and perhaps some slippage.

The risk reward ratio seems infinite at this point but of course it isn't infinite when you figure in commissions and potential slippage, but it was very high and clearly in my favor. I used an area of confluence to find a quality entry area and then carefully reduced my risk profile as much as I could and still give this trade every chance to mature.

Before I move on, let's contrast the way I framed this trade, especially compared to the earlier trade. In the earlier trade, I knew before entering the trade I was going to range trade for a relatively small profit per contract, but had a very small initial stop coupled with a solid 7-to-1 risk reward ratio. The entire profit potential, in my eyes, was $7 per contract. The second trade featured a much wider initial stop ($2.40 a contract) and while the profit target was nearly $20 a contract, I also planned on boxing in profits if price moved higher ― and remember, because I am long against up sloping lines, the longer it takes for price to hit the median line, the higher that intersecting price will be, so if I am able to box in profits under swing lows as they form, the profit potential may be more than $20 a contract.

It is extremely important to know what your end game strategy is when planning out a trade, make a plan and trade that plan. Each trade is different and the market structure and the opportunities you have to work with will dictate how you frame each trade. Don't range trade in a strongly trending market, and don't anticipate a trending market while price is stuck in the middle of a well-defined range. No matter what you wish for, price is always right and it will do what it does. Don't enter a trade without a complete trade plan that includes both a solid initial stop loss and a reasonable profit target.

Let's see how the gold futures reacted to the non-farm payroll number:

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You can see that my lotto ticket expired worthless when price traded lower after the number, stopping me out of my position at break-even.

Although I did have nearly $5 per contract of potential profit in this trade right before the economic number was released, because I had framed this trade as a swing trade and was looking for about $20 per contract, I was willing to allow myself to be stopped out at break-even. In many ways, this is the opposite side of the coin of the first trade, where I wasn't looking to work myself into a low or no risk stop ― instead, in the first trade, I wanted to get to a small profit floor if possible and grab a quick profit and exit clean.

Do I consider the second trade a failure? No, I was able to meet all my goals before the economic number was released. I put myself in a position to have a near risk free run to the upside IF the economic number was positive to Gold Futures; instead, the number was negative and I was stopped out at break even. In my eyes, both trades were executed as well as I could have executed them; the difference was simply price going where it wanted to go. And as I always say, price is always right!

I wish you all good trading. Read Part 1 | Read Part 2 | Read Part 3 | Read Part 4

Timothy Morge

timmorge@gmail.com
www.medianline.com
www.marketgeometry.com

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