Big Game Hunting

03/13/2013 6:00 am EST

Focus: TRADING

Risk is not just about how large your initial stop is and how often it's hit; it's also about management of profits before you close the trade off completely, writes the staff at Netpicks.com.

Trailing the market in the hopes of making big profits isn't always going to be the best thing to do in every situation. Markets which aren't trending (and most of the time, most are not) will come back on you and take you out for a much smaller profit than you might have taken otherwise; the losses however, remain the same. But with a little bit of common sense and a reasonable amount of practice, it's more than possible to apply this sort of technique without the need to increase the amount of risk on a trade when the context of the situation is right. Trailing for big game (and profits) is exactly what you need to do in these circumstances.

Given that it's not always going to be the best idea to go for the home-run trades, but you know they do exist, it's worth putting in a bit of work to figure out the best way to capitalize on any scenarios where the potential for one has elevated odds. A home-run trade can be tricky psychologically though. You have to remain focused on your everyday bread and butter trades and not get carried away into thinking you can pull a massive trade out of the hat every other trade. That said, if you're sensible and grounded about it, a few big trades here and there can really give you a fantastic platform to build on.

Here and there, you get situations crop up where the market is literally telling you it's ready to make a move. Like in the example I'll show you later on, one particular scenario is where a market has been balancing for several days and has several overlapping sessions. This usually happens when participants are waiting for new information and are unwilling to commit capital beforehand. This can happen for example, leading up to a US jobs report. When the data is released, and if there's a big surprise, there will be a big move.

If you're willing to do the background context work in trading and have a plan to trade it when the market is giving you a strong indication of what it's likely to do next, there's no reason why you shouldn't be able to capitalize safely on it when it does make the move. Incorporating a looser trailing stop in these instances can give you the opportunity to capture a much bigger than normal profit on a trade. However, given that the outcome of a trade cannot be known beforehand, it's of paramount importance to appropriately address risk in order to cover yourself when you are wrong and to maintain control when your position is in profit.

Being able to run a multiple-position strategy (and this is partly why product selection and account capitalization are so important) if done correctly, allows you to manage your risk throughout the trade. As more of the position is scaled out of, the risk of a profitable position turning negative diminishes greatly. This principle can be applied to the situation where you don't know how far a market is going to go in your favor and so you trail a stop in order to capture larger profits. By taking something off the table early on in the trade, you give the trade a solid footing. If done correctly, the trade can become virtually risk-free at this point, leaving the remainder of the position plenty of room to breathe.

NEXT PAGE: The Importance of Risk Management

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Risk is not just about how large your initial stop is and how often it's hit, it's also about management of profits before you close the trade off completely. If you have a strategy, for example, where your stop is normally around 10 ticks, yet your position is 30 ticks onside with a trailing stop at 20 ticks, your risk is elevated. By reducing the position size on the trade, you can actively manage this element of risk. Sure, you might not be taking as much on your winning trades, but what you are doing is protecting your account when the losing trades would otherwise occur or ensuring some level of profits depending on the stage at which the trade is.

There are just a few of words of caution I have for anyone who wants to trade in this way. Firstly, letting the market tell you when it's ready to move is massively important. Getting one or two big juicy moves under your belt is great, but every opportunity is different from the last. Whilst it might be frustrating when you see a potentially huge trade vaporize before your eyes, it's imperative that you act based on what the market is telling you it wants to do and rather than on what you hope it will do.

Next is that annoying situation where you miss an opportunity. Either you didn't see it soon enough through lack of concentration or perhaps you didn't have the confidence to pull the trigger. IF YOU GET IN A TRADE TOO LATE, YOU ARE INFLATING YOUR RISK ON THE TRADE. Don't worry about it. Let it go. There are plenty more fish in the sea. Finally, it's important to go into a trade (and in fact this applies equally to any trade at all) recognizing that you will never be likely to capture most of a move. If you hold on to a trade too long and beyond what you've planned for or you re-enter a completed trade because you think there's more in the move, you're increasing your risk or even worse you're entering into a situation where you haven't identified what your risk is at all. Be happy with what you've got, reset, and wait for the next trade.

Bund example

chart
Click to Enlarge

In the bund example above from last November, the chances of a big move were growing as a tight balance had developed over the course of the prior seven trading sessions. Trading the strategy with its normal trailer would have been a start, but considering that the potential for a far bigger move was on the cards, it was worthwhile running a much looser trailing stop once the usual targets had been booked.

In this case, the setup occurred right at the low of the balance zone and depending on how you trade, you might have given it an extra tick before entering rather than the 2 tick adjustment I show in the chart. Either way you can see that by trailing the yellow moving average by a couple of ticks (last bar close value +2 ticks in this case) on part of the trade, it was possible to take larger profits than usual whilst remaining in control of risk.

What is important to understand is that any strategy and its management should be founded in logic and reason. If you can tip the odds in your favor by recognizing when that logic and reason is most likely to hold true, you're in the best possible place to capitalize on your strategy. Trailing for big game (and big profits) is no different.

By the Staff at Netpicks.com

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