Identify Trend Potential and Protect Profit

Great traders routinely go through a checklist before initiating trades. The main questions they seek to answer are as follows. Is the market ready to trend? Is the move apt to be higher or lower? Where do I enter a trade? Where do I set risk? What is the profit potential?

On the top of the list for most traders is to identify when odds favor a sharp vertical move. The combination of below average day ranges with 3 to 5 days of severe overlapping prices along with small body candlesticks (similar opens and closes) are frequent factors for timing the inception of a trend.

When these conditions are met the next step is to choose an entry level. One method is to take a 5-day average of highs vs. lows. If the upper band is violated, a long position is taken. Conversely, if the lower average is penetrated, a short position is realized. Immediately after a position is taken, define risk.

To define risk, refer to the breakout levels above. If long, the stop loss should be set just below the 5-day average low. If a short position it taken, the stop loss should be set just above the 5-day average high.

For setting an initial profit target, refer to the average true range (ATR). Define the benchmark by calculating an average week range using 9 samples. Currently, the average week range SPY (S&P ETF) spans 6.4 points. So, assuming a long position is taken at 330, the profit target would be 336.4. If a short is executed, profit would set 6.4 points lower or 323.6.

As the market heads toward the target price, we need to manage the trade by protecting profit. To do so move the stop loss to entry price when 50% of the profit target or half the weekly ATR is realized.  With this technique you will scratch the trade for no loss if the market abruptly reverses.

John Seguin, Market Taker Mentoring

Trader Education