By Richard K
Introduction to Risk Management Strategy
Many beginner traders focus almost entirely on how to enter a trade and how much money they can make if things go their way, giving very little thought on how to actually manage their open position and limit their risk properly.
Proper position and risk management should be part of a successful strategy and be strictly enforced from the time a trade is opened until its final conclusion. What sets professionals apart from novice traders is the fact that they are excellent risk managers i.e. they know how to keep their risk to the minimum while at the same time allowing their profits to run.
The purpose of this article is to demonstrate a position management technique that addresses the following three questions:
- Where should I place my stop?
- When and how should I trail my stop?
- Where should I place my target/s?
To address these questions I will show you an actual trade I took, starting with how I entered it and how I’m currently managing it.
Note: At the time of writing this article this position was still open.
Hunting for Trade Setups
When I trade, I employ a strategy dedicated to doing the following:
Finding the end of corrections and entering low-risk trades when the trend resumes again.
My risk management strategy follows a step by step procedure to help me pinpoint the end of corrections which include:
- Determining trend or when a trend may end
- Finding areas or levels where a correction may occur
- Confirmation of a correction
- Using market geometry to find the most likely area where a correction could end
- Following a set of entry conditions to signal a trading opportunity
- Entering low-risk trades with large profit potential
What follows is a series of charts that illustrates the steps I took to find the end of a correction after which we will focus more on position and risk management.
Using a simple set of trend lines I determined that the USD/CAD pair might be in the beginning phases of a trend change or at the very least getting ready to re-test the highs made in December last year. This simple observation prompted me to look for long positions.
Finding areas where corrections may appear
Next, I used my Fib extension tool and anchored it to swings within this current upward move. The black box indicated that I had to use swings that were part of a certain type of correction, which would require that I use those pivots to accurately draw my extension ratios.
Price reached and reacted from the 100% Fib extension multiple times, indicating some sort of correction downwards.
The first time I actually looked at this chart was on the 13th February 2018 and I decided that a trading opportunity was on the cards if my 4 hour chart were to confirm a correction. An additional thing that made me excited was that the 4-hour chart also had trend lines that were broken to the upside.
Find the end of the correction
The chart above was the actual chart I was looking at on the 13th Feb and on it I drew a Schiff pitchfork which is a tool I use to find the end of my corrections. Note how I also identified a price zone where I thought the correction would end, ahead of time.
Two days later on the 15th of February market structure developed in a different way than I anticipated so I had to readjust my pitchfork and update the price zone I thought the correction would end at.
Entry conditions and setup
On the 16th February, price touched down in my price zone and right at the lower red warning line of my pitchfork. It was then time to look for an entry.
Using a much smaller time frame I looked for a few entry conditions that would signal an entry. I had momentum on my MACD histogram slowing down, a touch of my red warning line, and a bullish reversal pattern signaling that I needed to place an entry order slightly above the reversal pattern with a stop-loss order slightly below.
By following a set of entry conditions I answered the question about where I need to place my stop loss for myself. Where I place my stop loss is part of my strategy and I know exactly where to put it before I take a trade and never touch it until it’s time to trail my stop. If I get stopped out, that’s fine because my risk is always small and I accept the risk involved before I trade.
Low-risk trades and large profit
Using a combination of multi-timeframe analysis, market geometry and the use of entry conditions allows me to take trades that have very little risk with large profit potential. When I trade I set my ultimate target at a level from where the entire correction started.
This answers the question of where I should place my target BUT we have now arrived at the section where I will show you how you can use a simple tool like the pitchfork to help you with managing your own positions with regards to targets and trailing stops.
Position and Risk Management Strategy Using Pitchforks
Pitchforks are a form of market geometry that is often overlooked by traders as it gathers dust in their trading platform’s tool section. To draw a pitchfork an analyst needs to anchor three important swings or pivots on a chart and the pitchfork lines called median lines will be projected at an angle into the future.
When drawn correctly, the price will tend to follow a pitchfork’s angled direction and interact with its median lines.
A picture-perfect example was the recent decline in Bitcoin’s price and simply connecting 3 major swings on a 4-hour chart of Bitcoin shows how price interacted and respected that pitchfork’s median lines. Look at where that downward move came to an end, right at the lower blue median line.
I’m not saying that the drop in Bitcoin is over but I’m just illustrating to you how well a pitchfork worked on that chart.
Drawing pitchforks on any chart and any timeframe will show the same sort of interaction between price and median lines, therefore making it a useful tool to help set targets and trail stops.
Setting Targets and Trailing Stops(Stop Loss Orders)
Going back to the USD/CAD trade that I still have open and you will see that my target around the beginning of the correction was reached with no hiccups along the way. Even though price moved in the opposite direction than my original pitchfork, I just wanted to draw your attention to how price interacted with the median lines upwards again.
The proper way to draw your pitchfork when managing targets and trailing stops would be to use important swings that will angle the median lines into the direction of your intended trade.
On the chart above I show the original entry right at the low of that correction with the original stop loss. A great way to bank profits as your trade progresses is to take partial profit as price reaches your pitchforks median lines with your final target set at the upper blue median line.
Now to trial, your stop loss has just become easier if you follow the following suggestions.
- Once your center median line has been reached move your stop loss to break even plus a few ticks in your favor. You could also take partial profit at the median line if you want.
- Once the middle section between the upper median line and the center median line has been reached (blue dotted line) trail your stop upwards to behind the lower blue dotted lines.
- Once price breaks through the upper blue dotted lines and that high marked by the black line then you should be very close to your final target and you should aggressively trail your stop loss higher to below the center median line.
If you follow this simple procedure you will allow the market enough room to move in while hiding your trailing stops behind market geometry lines. Also, note that since the median lines are angled upwards the price of this pair will increase the longer it takes for price action to get up there and you should therefore adjust your targets and trailing stop orders as price and time progresses.
This last section addressed the question of how to trail your stop-loss orders and this very simple technique I showed you works very well to prevent you from being stopped out too early while booking profits along the way. Price likes to gravitate towards median lines which makes them very useful in helping with managing open orders properly.
Position Management in Trading: Conclusion
This trade has already gone 300 + ticks in my favor while only risking 13 odd ticks. That is massive and these sorts of trades happen often if you know how to catch them.
I only offered you a glimpse of my strategy and what sort of returns are possible when I hunt for the ends of corrections. In the example, I showed you I correctly identified the exact low of that correction and had plenty of time to prepare myself for an entry.
If you ever wondered what it takes to achieve similar results with your own trading then be sure to check out my full course here.
I hope you enjoyed what I have shown you and that you will consider including the pitchfork technique as part of your risk management strategy.
Until next time,
All the best.