In our quest to develop a trading approach, a few of weeks ago we decided that these were the keys points to include in our strategy:
1. Determine whether you are looking for a buy or a sell.
2. Find your entry.
3. Identify your initial risk.
4. Find your exit.
We have gone through how to determine whether we are buying or selling and also how to identify our entry. This week, let’s take a closer look at our entry and where we should place our initial protective stop. When we are using technical indicators such as the Slow Stochastics to better time our entry, we want to make sure that the market has bounced off of support before entering into our buy. This way we are entering as the market is rising instead of falling which increases our chance of success on a buy. So our trade is identified as the Slow Stochastics (Slow K on the chart) moved below 20, then crosses up over the signal line (Slow D) and then closes above the 20 level. It is important to wait for that candle to close to confirm that the Slow K line did indeed close above 20. We then buy at the open of the next candle. But before that we also want to identify our risk on the trade. At this point, if the market were to trade down below the recent low of the reversal, I would consider my interpretation of the mood of the market wrong and would want to be out of my trade. This market shows an entry of 1.2663, with a stop placement below the 1.2606 low. So I am buying at 1.2663 and at the same time, placing my protective stop at 1.2605. Some traders may want more cushion below that low and I could see placing the stop at the 1.2599 level to take advantage of the natural support that an even number like 1.2600 might provide. But I usually consider a move through support as a move through support and do not want to be in the trade any longer. So, I now know my risk is 58 pips.
If trading in a mini account, the value of one pip on the AUD/NZD is 74 cents (US), so my risk on the trade is $42.92 per mini lot. If I have a $2000 account balance and want to keep my total risk on the trade to less than 5% of my account balance, I can open up two mini lots. That would be a total risk on the trade to me of $85.84. We get this by multiplying our $2000 account balance by .05 (5%), which is 100. So we do not want to risk more than $100 on the trade. This should be done before you enter into the trade, so you know how many lots you can open. So we have identified that we want to buy since the daily chart shows an uptrend. We want to buy pullbacks off of highs down to a support level and we have used Slow Stochastics to help us time our entry. We also know that we should always trade with a protective stop in the market and we identified where that stop should be and how to calculate our risk on the trade in pips and also in a dollar amount. Next week we will look at how to exit our trade.
