How to Manage Trading Risk Effectively

How effectively you manage your trading risk is the key to making trading sustainable. As Warren Buffet puts it, “Rule number one in investing is, don't lose money; rule number two is, don't forget rule number one.” Any trading software can suggest stop-placement, but you should be aware that the type of stops you use could determine if you win or lose.

Arbitrary Stop Placement

A protective stop is used as a defense measure to protect gains or to limit losses. How does it work? The trader typically places a “stop-loss order” at a predetermined dollar level. If the market moves against the trader's position, the stop will automatically liquidate the position and limit further losses.

You should never feel comfortable using an arbitrary stop like this. “Should I use a $200 stop loss or a $500 stop loss?” is a typical question from traders who use arbitrary stops. Questions like these keep these traders constantly on edge and don't offer ultimate protection.

AbleTrend Intelligent Stops are based on the market's own support and resistance levels

AbleTrend software uses principle-based or “intelligent” stops - stops defined by the market's own support and resistance levels. The software identifies market support levels with small blue dots below the bars for buy positions, and identifies market resistance levels with small red dots above the bars for sell positions. Here are some sample charts showing the small dots indicating stop placement are based on.

AbleTrend defines market support levels with small blue dots below the bars

AbleTrend defines market support levels with small red dots above the bars

AbleTrend defines market support levels with small blue dots below the bars

AbleTrend defines market support levels with small red dots above the bars

The Importance of Defining the True Market Support and Resistance Levels

The concepts of support and resistance are undoubtedly two of the most highly discussed aspects of technical analysis. They refer to price levels on charts that tend to act as barriers that prevent the price from pushing through in a certain direction. A key turning point is where the move is rejected at the barrier and price turns back. This is why support and resistance play a big role in trading.

What is the single most important piece of information in terms of technical analysis? It is the price. The price is what the market is directly telling you. There is no delay. The market tells us in any moment the price that has been agreed upon by both buyers and sellers.

What is the single most important piece of information in terms of the market price? The answer is, the support and resistance levels.

Based on its most recent prices, a market defines its own support and resistance levels. These levels are not based on anything you or anyone else may think about a market. These levels are the overall result of all market forces, actions, and interactions. Knowing this, it should be clear why all of your trading decisions from this day forward should be based on where areas of support and resistance can be identified that are defined by the market itself. Support and resistance levels can manifest themselves in many forms, including trendlines, previous highs or lows, or a percentage retracement.

Support

As the term implies, support is the price level at which a declining, or bear market stops going down. Think of support as a price floor that prevents the price of a market from being pushed further downward. As a market approaches support, it tests its support level. If prices reach a support level and stop, then that may indicate there is buying strength in the market. If, however, prices breach a proven support level, that usually indicates continued weakness in the market.

The ability to identify a level of support can coincide with a good buying opportunity because this is generally the area where market participants see good value, begin buying, and therefore start to push prices higher again.

Resistance

The term "resistance" also gives us a suggestion into its meaning when it comes to chart analysis. Resistance is a price ceiling. A market moving up, or a bull market, must show increased strength when confronted with a resistance level if it is to break through, or else it may burn out and fall back.

For example, in trading, at times it may seem impossible for traders to push the price of the market above a certain level. Something appears to be resisting the upward movement of the price. Resistance levels are regarded as a ceiling because there seems to be a barrier at these price levels that prevents the market from moving prices upward.

The Market Defines Support and Resistance

New traders might think that identifying these support/resistance levels is easy. But in fact, support and resistance can come in various forms. Real and false signals are often mixed. As a result, identifying support/resistance is much more difficult to master than it first appears. Among the more common forms in which support and resistance levels present themselves are trend lines, round numbers, moving averages, percentage retracements, or a previous significant high or low on the chart.

AbleTrend2 (T2) is a key innovation of AbleSys

AbleTrend does not use any of above-mentioned ways of defining support and resistance levels. AbleTrend uses AbleTrend2 to detect major support and resistance. Our users say that they value T2 more than any of the above-mentioned indicators, and they never trade against T2.

How to place stops for the most protection

A common mistake traders make is to arbitrarily place stops without respect to the market's price action or movement. A trader may decide to risk some amount such as $200, $500, or $1000. Where do these numbers come from? They are arbitrary. In reality, market conditions vary from trade to trade, time to time, day to day, and market to market. Nothing is fixed. That's why traders enjoy an advantage when they let AbleTrend show them the placement of optimal stops, which are defined by the market price and action itself. Here is a recent chart showing stop placement based on support and resistance levels.

AbleTrend Intelligent Stops are based on market support/resistance levels

Where should we place our stops for the most protection? It's easy when we place our stops at logical levels as dictated by AbleTrend. AbleTrend T2 support levels indicate supporting floors for buy positions; AbleTrend T2 resistance levels indicate resistance ceilings for sell positions as shown in the above chart.

AbleTrend stops are placed at 1.5 to 2 levels away from price below the T2 support levels for buy positions, depending on your risk tolerance; AbleTrend stops are placed at 1.5 to 2 levels away from price above the T2 resistance levels for sell positions, depending on your risk tolerance.

AbleTrend dynamically places and moves stops according to current market action. What does the market tell us? The current price scale and range tell us the probable price range in the near future. The current price trend tells us the probable market direction in the near future. AbleTrend is designed to use the market's own predictions to place stops - or put another way, it places stops by a process of calculated reasoning.

Advantages of AbleTrend Intelligent Stops

One criterion for selecting a good trading system is that the system should have a built-in dynamic stop system. AbleTrend stops are principle-based. They are defined by the market's own support and resistance levels.

They are the new generation, of intelligent stops. These intelligent stops are dynamic and are automatically calculated with the built-in feedback loop of the software as prices change. Because AbleTrend stops are determined by actual market support and resistance levels, they are objective, easy to use, and they are highly recommended by many of its users.

Click here to view more about AbleTrend intelligent stops.

Click here to view more examples of AbleTrend signals and stop placement.

Tomorrow we will show you how to identify and trade choppy markets using AbleTrend Guidance Charts.

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For your prosperity,

The AbleSys Team