Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Tips for Anchoring Trades
11/02/2015 6:00 am EST
Many traders use anchoring as a filter in their trading plan in an effort to limit their risk on a trade, says Rick Vinecki of Beyond Profile.
"I was taught to 'anchor' my trades by following the overall trend using a higher time frame chart. I use a 5-min chart using a 60-min. anchor. Do you have any experience using such a strategy? It seems to work on paper but in the end I'm not sure if it hurts me or helps me?"
Great question. It's probably semantics but let's clarify what the anchor is and isn't. Anchoring, or using a larger time frame as the trend indicator and only trading with that trend using a smaller time frame, isn't a strategy per se but more clearly acts as a filter in your overall trading plan. So in your case, you would go long on some form of trigger on a 5-minute chart and only trade those triggers in the same direction as the 60-min trend.
Many traders use such a filter in their plan in an effort to limit their risk on a trade or perhaps better said; take the trades only with an overall edge. One needs to consider their risk management not only on a specific trade but with your overall trading plan. Remember, risk management is not just how to keep yourself out of trades, but understanding the opportunity cost of a decision to staying out. If such a filter is keeping you out of good opportunities then the anchor strategy you are using is not an effective one, or is 'too tight.' The best way is to compare such results is by back-testing it over a valid sample period (at least 100 trades over a 90-day period to keep things simple).
From my experience, I have found that the ratio of the anchor vs. trigger chart plays a big role in the overall effectiveness. For example, having a 240-min chart anchor when using a 1-minute chart can greatly reduce the effectiveness of the filter. A '60-5' method that you are currently using may give you a nice filter but often will find that you are entering on the 'late bar' with many entries. Adding a TICK chart or similar trigger to further hone in on your entry should help in this regard, as well as drilling down to trying a 15-minute anchor. Also, having too large of a time frame anchor can be equally as problematic as too many filters. An effective strategy I have used is entering with ? size on the 5-60 and adding one with a more narrower filter such as 5-15. Being flexible on the entry is fine, however do not wait for the anchor to turn to get you out. Use it as an entry trigger only and let the stop be your protection. No one wants to be wrong only to have to wait for an anchor chart to tell you something you already know.
By Rick Vinecki, Founder, Beyond Profile
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