Forex Education

How to Set Stop Losses

Stop placement is a topic that sometimes causes confusion amongst traders. This Price Action article is going to be a complete guide to how to set stop losses for the pin bars, fakey’s , and inside bars. Hopefully this will eliminate any confusion you may have had about this topic and will give you a guide that you can refer back to as you need. Consider this another supplement to the course material. Enjoy.

Setting stop losses on the pin bar setup:

• Standard pin bar stop placement

The “standard” or “normal” stop placement on a pin bar setup is near the high or low of the pin bar tail (depending on the direction you are trading of course). I normally place my stop 5 to 10 pips above the high or 5 to 10 pip below the low. No need to play the game of “how many pips above or below the tail is best?”…just place it at least 5 to 10 pips above or below, either the setup works or it doesn’t, don’t over-analyze it.

Now, placing your stop above the high or below the low is the “default” stop placement, meaning, if you are in doubt, place it there. It’s also the most logical stop placement since you are forcing price to invalidate the setup by violating the high or low.

Price-action-trading1

• 50% pin bar stop placement

When you enter a pin bar at the 50% retrace level, you obviously have to place your stop above the high or below the low, or further out if there’s an obvious level close by. When you enter a pin bar setup on a stop entry on a break of the pin low or high, you have the option of placing your stop near the 50% level of the pin bar, this works especially well on long-tailed pin bars that don’t retrace.

You can think of the 50% level of the pin bar as an “imaginary” pivot area. It can be a stop reference / placement point and also an entry point, depending on how you are trading the pin bar and current market conditions.

Price-action-trading2

Setting stop losses on the fakey setup:

• Standard fakey stop placement

For the fakeysetup, the “safest” place to put our stop loss is generally going to be just above the high of the false-break bar or just below the low of the false-break bar (depending on the direction you are trading of course).

Price-action-trading3

• 50% fakey stop placement

Two other options are to place our stop near the 50% level of the false-break bar or near the 50% level of the mother bar. These options give us a little more flexibility; especially on fakey setups with larger mother bars they give us the ability to get a better risk : reward to make the trade setup more practical.

However, if you are placing your stop near the 50% point of the mother bar or false-break, you are better off waiting to enter on a break of the mother bar high or low instead of entering on the inside bar break, this will ensure that momentum is in your favor, which will be important since you don’t have the added “protection” of having your stop above the false-break high or below the false-break low.

Setting stop losses on inside bar setups:

• Standard inside bar stop placement

The safest place to put your stop loss on an inside bar setup is just above the high or below the low of the mother bar. This gives your inside bar setup the most “room to breathe” and forces price to invalidate the setup by moving past the mother bar high or low before stopping you out, if it moves against you.

Price-action-trading4

• 50% inside bar stop placement

You also can place your stop at the 50% level of the mother bar. This gives you the ability to get a good risk : reward but you also sacrifice some of the room to breathe that you have with the standard inside bar stop placement. The 50% inside bar stop placement is best suited for inside bar that are larger in range, for smaller inside bars you will want to use the standard stop placement. Once again, this is obviously a bit of a discretionary decision, but price is a discretionary trading strategy, so you will get better at this over time.
Price-action-trading5

The successful Forex trader

$010I want you to write this down so you can see it every single day! It should be your mantra. Memorize it!
“The successful trader isn’t the trader who doesn’t lose, The successful is the trader who can successfully manage his losses”.
I was talking to a fellow trader this evening, and we talked a lot about the emotional, trade, and risk management aspects of trading. What it all boils down to is how 90% of traders don’t get these aspects under their belt. They fight it to some degree. If it doesn’t have anything to do with the actual system, it’s not worth talking about. This is a costly point of view, it will make you unsuccessful as a trader. This is why 90% of traders fail.
The 10% that do manage to embrace it are the few that do succeed. YOU are going to be among the successful few!
It’s important to know that losing a trade is no reflection on you as a trader, it happens to ALL traders. It doesn’t mean you can’t trade and it doesn’t mean you failed.
It’s how you manage these losing trades that makes you a good or bad trader.
If you lose a trade due to not trading the system, you might be a poor trader.
If you lose a trade because you jumped the gun, you might be a poor trader.
If you move your stop loss and end up with a large loss, you might be a poor trader.
If you trade based on emotions, you might be a poor trader.
You are none of these. You manage your trades. You take your losses in stride. The system dictates your trade management and you follow it. Your losses are never large, never more than the allotted risk. You understand that losses happen and you don’t let it get you down, you keep trading.

Tools for identifying Trending markets

Trending markets are by far the easiest to trade and thus the most profitable. Also, I really think all beginners need to learn how to trade with the dominant daily trend before they attempt to trade range-bound markets or counter-trend. So, knowing how to correctly identify a trending market is very important to being a skilled price action trader. I hope this article improves your ability to spot trends and trade them.

Tools for identifying trends :

• EMA’s

The general rule of thumb is that when they are crossed higher there is bullish momentum and possibly an uptrend, and when they are crossed lower there is bearish momentum and possibly a down trend. I say “possibly” because as the EMA’s lose effectiveness in trading ranges.

So, we have to combine the 8 and 21 daily EMA’s with other tools to properly identify a trending market…

Analysis of daily chart price movement

Learning to identify patterns of higher highs / higher lows and lower highs / lower lows is an important discretionary tool for identifying trending markets. We can see in the chart below an example of the daily EURUSD recent uptrend; we had the 8 and 21 cross higher and then a series of higher highs and higher lows. You have to learn to spot the moves and then the counter-moves, the daily chart is best for this; traders often get tripped up trying to identify trends on lower time frames. Our primary time frame for trend identification is the daily chart. Look at the example below of how to identify higher highs / higher lows. It is just the opposite for a downtrend with lower highs and lower lows. Also, look how these “confirm” what the EMA’s are showing you. A trending market will have both of these trend “tools” in agreement:

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Zooming out to see the big picture

Sometimes we get caught up analyzing only a week or two worth of price data. But, to identify the longer-term trend, we really need to zoom out and look at the last 6 months to 1 year of price action on the daily chart.

Zooming out and actually looking at the overall picture to see what the obvious slope of the market is, is a really good way to just get a quick and clear idea of the underlying market trend.

Let’s look at the daily chart of the AUDUSD for an example of how to zoom out and use what you see to determine the underlying longer-term trend. Note the market is obviously moving higher from the left side of the chart to the right side. This chart screen shot is showing about 1 year of price data. We can see there is an obvious major level here at 1.0200 and that price is still above this major level. So, the trend is still clearly up, even though recently this market has seen some short term downward movement. The point here is that it’s good to zoom out and look at the last 6 months to 1 year of price action to get a general sense of the longer-term daily chart trend. Having this bias will give you a point of reference for the 4hr or 1hr chart, and obviously for any daily chart setups as well. Although, I recommend all beginners stick to the daily charts and really “master” them before moving down in time frame.

 

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Horizontal Lines – Fading key levels with price action trigger

 This strategy is meant to show the simplicity and power in simply looking for two things: a key level in the market (horizontal line) and an obvious price action signal. Some of the biggest moves in any market are signaled by a price action setup that formed at a key level, as well as some very lucrative short-term moves as well. What I mean by “fading” is trading against current momentum from key levels at extremes. We are looking for a rotation back to value as I teach in the course. For this particular strategy we want to see an obvious price action signal as our entry trigger, combined with a key level. Let’s look at some examples to learn more:

In the chart below we are looking at the daily GBPUSD, we can see a very key and obvious horizontal resistance level through about 1.6175. Price had made significant rejections at that level two previous times recently when on November 1st a very well-defined pin bar setup formed showing rejection of the level. Now, every price action signal is a little bit different, and that’s why we need to use discretion when trading these setups, so I don’t really believe in “perfect” setups, but as far as pin bars go, this pin bar from November 1st is about as “perfect” as they come. It had a good sized tail that was clearly protruding from the surrounding price action as well as rejection a very key level in the market at 1.6175; the market also had the exact same open and closing price.

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Next, we are actually looking at the GBPUSD daily chart again, but this time it’s a zoomed out view. I wanted to show you guys just how powerful a price action signal at a key level can be. Note the key long-term resistance at 1.6300. Why is it “key resistance” you might ask? Well, basically it’s because it caused price to stop and make a significant move in the opposite direction…or rather a large longer-term move. Thus, when price retraced back to that resistance in mid-September, we would have wanted to have our eyes peeled for an obvious price action sell signal to “fade” the up move from a key resistance. As we can see, a very obvious pin bar sell signal did form there on September 21st:

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In the AUDJPY daily chart example below, we are taking a look at an example of this “fading key levels” strategy that did not work. It’s important to show trades that failed too, because you aren’t going to win every trade, even ones that look “perfect”. This pin bar at a key support level had all the makings of a good pin bar “fade” trade, but as we can see price broke higher only briefly before falling again and moving down past the pin bar low. It’s worth noting that soon after that price did shoot significantly higher, and we could have gotten in on this large move from a subsequent pin bar that formed on October 15th, which kicked off the current uptrend in this market. So, the point is that if we stick to our edge, our winners should eventually out-pace our losers:

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Forex Holly Grail

2014-07-05_170948If you have been in forex trading for more than a week, you will have heard of the legendary HOLY GRAIL of trading. The Holy Grail is characterized as a trading system that never loses, only has winners 100% of the time. The perfect entry signals followed by the perfect exit signals.

Once you get your feet wet, new traders have a tendency to go on the hunt for this legendary trading system. They try all the indicators they can find, messing with different settings and different combinations. They think that they will be the one that will discover that perfect combo. To many traders get lost in this search that they forget about trading. This leads to system hopping and never sticking to one system long enough to make it work.

This version of the Holy Grail doesn’t exist, it can’t exist. It would mean that the Holy Grail would have to be able to predict the fundamentals in the world. These fundamentals are events in the world that make the market move… natural and un-natural disasters, bank defaults, huge money transfers, unexpected business transactions, the million and one things that effect the market. Since no technical system can factor in these real world events, no trading system can work 100 percent of the time.
So if this Holy Grail can’t exist, what would be the “Real Holy Grail”?

In our personal land of Forex, I consider the Holy Grail to be not the perfect system, but instead, a great trading system with great trade management and great money management combination.
These 3 aspects put together, sprinkled with a heavy dose of personal discipline, can make a trader rich. This is the Holy Grail of trading… any trader who is a success, I believe, will tell you the same thing.
What is your Holy Grail of trading?

Leverage, Margin and Lots

2014-07-05_170620In order to make this small 100th of a cent worth something, your broker offers you leverage. This essentially magnifies your trade size. You would place a trade using so much of your own money, called Margin, and your broker will magnify the trade by whatever the leverage is. If your broker offers your 100:1 leverage, this means they will Increase your trade size by 100 times.
You have to trade chunks of money called Lots. Different brokers offer you different minimum lot sizes you can trade.
There are 3 different sized lots, each make the value of a pip worth more or less.

1 Micro Lot = approximately $0.10 a pip

1 Mini Lot = approximately $1.00 a pip

1 Lot = approximately $10.00 a pip

Opening a “micro account means you have the abilityto trade lot sizes as small as you can get. This is good for small accounts. Most brokers will allow micro lot sizes and let you open an account for as little as $250.00.

To trade a lot, you have to put up some of your own money, this is called margin. How much margin required depends on the leverage. If you are trading an account that offers 100:1 leverage, you will need about $10 of margin to trade 1 micro lot. If you are trading an account that offers only 50:1 leverage, you will need about $20 of margin for the same micro lot.

This margin is held in good faith by your Forex broker until the trade is closed. You can gain more or less, or you can lose more or less than the margin you have put up. Whatever the case, the margin is returned to you after the trade Is closed. Again, this Is all done automatically through your broker. You can trade as many lots as you wish, providing you have the margin to cover it.

##A note about US brokers :

Recently, a Forex governing body called the CFTC (Commodities Futures Trading Commission) has implemented several restrictions to US based brokers. One of these restrictions is to limit leverage to 50:1. This means that your broker can only magnify your trade 50 times as opposed to the usual 100 times. This should not be an Issue In your trading, so don’t worry about it too much.

Forex Money Management

With a strong knowledge on how to read your forex chart, you are now ready to trade. However I will like to take this chance to talk about something known as the trade management. Without proper trade management, you will never be profitable as you will always find yourself being stopped out in the end.

This is the exact thing that I do whenever I am trading and I hope that you will put it to practice as well.

The most important thing in trade management is never to adjust your stop loss to put you to greater risk as well as cutting short your target profit. This will lead to you constantly trading with low risk reward ratio.

For example: You enter a SHORT trade and you see the price slowly moving toward your stop loss of 30 pips and you decide to shift the stop loss to 50 pips hoping that the market will eventually move in your favour.

Most of the time, you will find that the price will still stop you out at the 50 pips which means that you are now trading with more losses. As a trader, we have to accept the fact that we are in a wrong trade whenever the price moves to stop us out and not to shift the stop loss to incur bigger loss in the end.

This is a very common mistake made by new traders as they are unable to accept any loss in their trading. So I am going to share with you something that I usually do in my trading.

Whenever the price moves against my position, I will stick to my stop loss and if the price ultimately stops me out, I will accept it and look for another trade to occur.

If the price moves in my favour, I will slowly shift my stop loss to breakeven and eventually wait for the price to hit my target. In this case, even when the price reverses to stop me out, I am not losing a single pip and this is how I protect my capital.

The creation of a speculators’ wealth comes from how they manage.

Until you use a money management approach, you will be a two-bit speculator, making some money
here, losing some there, but never making a big score. The brass ring of commodity trading -will always be
out of your grasp as you sashay from one trade to another.

As a trader, it is very important for you to understand the importance of protecting your capital. To a professional trader, protecting his/her capital is more important than winning a trade. If you are planning to become a profitable trader one day, you must understand and apply this good trade
management skill to your trading.

Another approach to this money management system I want to show you is a more conservative/safe tweak that can be added, at the cost of some reward potential.
Instead of opening one trade order, you open two instead, both with the same stop loss and entry
prices. The only difference is you split the total amount of money you want to risk on the trade
between the two orders. So if you want to risk $200 on the trade, you set the two trades at $100 risk
each with your lot sizing.
On one of the trades, set your target for a risk/reward of 1:1
On the other trade, set the target as your original target price for the trade.
When the 1:1 target trade gets hit, you collect $100. This $100 now covers the risk on your second
trade which is still open. This makes the second trade a “free trade”, because if the second trade was to get stopped out, you would lose no money. First trade was +$100, second trade gets stopped out
-$100. The only way you can lose money with this tweak, is if the 1:1 trade does not hit target and
both trades get stopped out.Forex-Money-Management

What Is The Trend ?

Before we get started, we have to determine what a trend is before we can trade it. A trend, to a trader, is based largely on the timeframe they are trading. As you have learned, the 2 most important timeframes, as far as I’m concerned, is the timeframe you are trading and the next higher timeframe.

For example, if you are trading the 1 hour timeframe, the important timeframes would be both the 1 hour and the 4 hour. The 1 hour is the timeframe you trade, the 4 hour becomes the timeframe that helps you decide if you are trading in the right direction. This relationship exists with both trend trading and counter trend trading.

When we look to find a trend, we will be looking at the timeframe we are trading and the next higher timeframe, but the focus will largely be on the timeframe we are trading.

A trend is a continuous move in the market either up or down. During a trend, the market will make small corrections (or pullbacks) along the way, giving you a zig zag look, but overall, the market is moving in one direction.

Below you see an artistic example of an uptrend. The overall direction is upwards as price moves from the lower left to the upper right. During the move there are small retracements against the trend, but overall, the direction is up.

Upward-trend-up-trend-forex-trend-long

Below is an example of a downtrend. Price moves from upper left to lower right, and even though there are small corrections along the way, the overall move is down.
forexwinners-down-trend-downward-trend-line-short-trend

How To Identify The Trend

Here is where things get crazy!
Not really, actually this is the simplest part of the entire method. Albert Einstein once said “Make things as simple as possible, but not simpler”, and to that end, here is a good way to identifying if a market is in a trend.

Use two Exponential Moving Averages:

21 EMA
55 EMA

When the 21 EMA is over the 55 EMA, the trend is up.
When the 21 EMA is under the 55 EMA, the trend is down.

This definition of a trend is an oversimplification, but it’s where we start.

Keeping my charts clean is important to me, and adding the additional moving averages can make things a little more cluttered than I usually like to see.
For this reason, I color the 21 and 55 EMA’s a grey color so they blend into the white background of my charts to some degree. On a black background, a darker grey color for the EMAs would be my preference.

Below is an example of what my chart looks like with the 21 and the 55 EMA’s.

EMA-trend-line

The lighter grey color on the white chart doesn’t become overwhelming and distracting, and this is important to note. As we trade FMM, we will be taking trades that occasionally go through the lines, and other times we will be using the lines as both targets and as areas of support and resistance.

I don’t want you to become too distracted by the lines, and having them subdued  is one way to keep them in the background. They are there when we need then and quiet when we don’t.

Why the 21 and 55 EMAs ?

You can experiment with other settings as you like. The 13 and 21 are common for moving averages. Over a lot of testing, I have found the 21 and the 55 to be the most reliable in determining a trend. They are slow enough that they determine when a real trend has legs, but fast enough to not lag behind the change of a trend too long.

As you look at a chart with the 21 and the 55 EMAs, you will see that both of  these MA’s are extremely strong levels of dynamic support and resistance, and this element makes these great MA’s for trend following.

Price never strays too long before returning to the 21 EMA and then the 55 EMA.
This is an important aspect to counter trend trading, price moves away from the moving averages, but very quickly will return to these levels. And because of the excellent ability to provide support and resistance, these moving averages also make incredible targets.

The 21 and the 55 EMAs work on all the timeframes, from the 1 minute to the monthly. This simplifies things as well, not having to look at different MAs for different timeframes, and as you know, simple is good!

Feel free to try out your own settings, experiment with many combinations, with  exponential and simple, or a combination of the two, you might find something that you feel works better for you. Either way, the following pages will show you how to use them.

21 EMA and 55 EMA as support:

EMAs-support

21 EMA and 55 EMA as resistance:

EMAs-resistance

Even as the 21 and the 55 are great areas of support and resistance, they are also excellent at drawing the price back to it. This concept all on its own makes these moving averages great targets on counter trend trades.

Below is an example of Gold (AU). Lately, Gold has been on an incredible trend,  and as you can clearly see, the moving averages have provided excellent support as price has been moving up, but at the same time, Gold prices have always come back to the moving averages.

Viewing the MAs as support, resistance and targets opens up a new world of  trading possibilities!

EMAs-magnet

Confirming The Trend

Here is where we get to the goods, the actual techniques used to trade with the trend.

The first question you might have is “do we need a divergence setup to trade with the 21 and 55 EMAs”, and the answer to this is no. We are taking advantage of a trend, so I will show you how to capitalize on the market’s ability to move with the trend.

Hidden Divergence is an awesome tool, but as a trend continues, there are more opportunities to enter the market than Hidden divergence will always allow for.

First, the beginning of a new trend direction is when the 21 EMA crosses over the 55 EMA. When 21 crosses above, we have the potential start of an upward trend, when the 21 crosses below the 55, we have the potential start of a downward trend. I say “potential” because even though we get a crossover of the MA’s, we don’t always get a trend that forms from it.

Next, we look for confirmation of the new trend. What we look for is a bounce off one of the moving averages. When the 21 crosses up over the 55 to begin a new uptrend, we want price to drop back down to either the 21 or 55 and use it as support. This is confirmation that that new upward trend has formed.

Below you see an image of the 21 EMA crossing over the 55 EMA signalling the potential for a new trend, and then we get a bounce off the 55 EMA confirming the new trend.

Confirming-The-Trend-Line

Prior to the chart example above, below you see three examples of the 21 EMA crossing over the 55 EMA, but in each case, we do not get the confirming price bounce off either of the moving averages. Price simply crosses back across the EMAs never using them as either support or resistance

 

Confirming-The-Trend-Line-1