What Is Missing in Your Risk Analysis?
Stop Loss with Support & Resistance
The least used and most often improperly used analysis by Technical Traders and Retail Traders is Risk Analysis. All too often, traders are choosing high-risk stock picks without realizing it. See the candlestick chart example below.
This analysis is NOT using percentages, but rather using the technical patterns within the chart in order to do the following:
- Finding the lowest-risk trade from a group of potential stock picks.
- Determining Risk vs. Run Gain Profit Potential BEFORE placing an order.
- Determining the correct Stop Loss placement for your stock picks to avoid setting it at a whipsaw point. In addition, avoid not using a Stop Loss at all due to not knowing how to use and set them correctly.
- Selecting the strongest stock picks based on Risk Analysis, which reveals weaknesses that do not show up in Candlestick Patterns or MACD Patterns.
- Choosing stocks with Risk that you can tolerate. Too many times, traders get greedy and choose stock picks that have higher Risk than they are ready to accept.
First of all, stock Stop Losses should NEVER be calculated as Percentage Stop Losses. This is an ancient and out-of-date method that is the main reason why so many Retail Traders believe that Stop Losses do not work.
They are accidentally and unintentionally setting Stop Losses based on a percentage that puts them right in the middle of a profit-taking area where High Frequency Trading will trigger OR where Dark Pool bargain-hunting Time Weighted Average Price orders are sitting and waiting for Price to drop into that range.
Explorations Beyond the Basics
MetaStock Webinar includes how to create a scan that tracks Dark Pool Quiet Accumulation. Click HERE
Candlestick Patterns Webinar
Learn which patterns work all the time, how many patterns you really need to learn. Click HERE
High Frequency Trading Action webinar to learn which setups cause automated High Frequency Trader orders to trigger and why. Learn MORE
Trading the automated markets along with Stock Market Participant Groups that use Time Weighted Average Price (TWAP) orders, Volume Weighted Average Price (VWAP) orders, and High Frequency Trading predatory millisecond orders requires using MODERN analysis and tools. It is hard to abandon techniques learned on the internet that appear everywhere, but in order to be successful, traders need to change how they approach trading.
Support and Resistance Analysis
When choosing a stock to trade among a group of stock picks, consider Risk Analysis of the trade based on technical Support and Resistance Levels appropriate for your Trading Style. Stock Market Trading Styles include Intraday Trading, Day Trading, Swing Trading, Momentum Trading, Position Trading, and several others.
Trading Strategies are selected AFTER a Trading Style has been chosen. Certain Trading Styles require specific Technical Patterns, Candlesticks, and Support Levels for optimal trading success. Buying Long versus Selling Short also changes Support and Resistance Levels for each Trading Style.
The calculation must be made for Support, which is where the stock is likely to bounce up as indicated by the green line. It may not hold over time, but it is the first level of Support for this stock if it sells down further. Therefore, Support is based not on a percentage, but the technical levels where bounces occur from Buy to Cover Professional Traders closing their positions OR from “Buy the Dip” Small-Lot Investors rushing to buy into what they believe is a bargain.
As an example of stock chart Risk Analysis, see the chart above, which has an Engulfing Black Candlestick Sell Short Signal. As a Sell Short stock pick consideration, the chart shows that the Resistance is above Price as indicated by the red line. This is where the Stop Loss must be set rather than a percentage. A tight percentage puts the Stop Loss in the middle of the Resistance which will create a whipsaw, and a larger percentage such as 8% or 10% puts the Stop Loss far too wide, adding Risk to the trade.
By calculating the difference between the Resistance and the Entry Price, the Risk of the trade is determined. By calculating the Support Level where the stock is most likely to pause or bounce, the Run Gain Profit Potential is determined. The final step is dividing the points at risk by the points for the Run Gain Profit Potential. The Risk/Profit Ratio should be 3/1 or higher. Most of the time, Retail Traders are trading stocks with higher points at risk than there are potential points to gain.
Taking the time to calculate Risk using Risk Analysis will significantly improve your profitability by eliminating high-risk and low-profit trades.
Go to the MetaStock Learning Center and watch training webinars Trade Management Planner, Velocity Swing Trading, High Frequency Trader Action, and Explorations Beyond the Basics.
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Martha Stokes CMT
TechniTrader technical analysis using a MetaStock chart, courtesy of Innovative Market Analysis, LLC dba MetaStock
Chartered Market Technician
Instructor & Developer of TechniTrader Stock & Option Courses
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