For decades I have published futures updates for treasuries, forex, metals, energies, equities indexes and grains. To do this daily task I have a routine for each sector. Aside from examining fundamental data, I use a few technical indicators. The most practical indicator I employ is Average True Range (ATR). This versatile gauge can be used to set support/resistance areas, profit targets and risk. By comparing ATR from the near term against a long-term benchmark this tool may also be used to determine if a market is overbought/oversold or wound too tight.

Setting Profit Targets

Prior to breakouts or acute vertical moves markets will often go through a series of days and even weeks with below average ranges and volume. These congestion patterns often take the shape of a rectangle (flag) or a pennant (triangle). I believe the time it takes to develop these patterns may be directly related to length of the breakout or profit potential

For example, assume a flag or channel pattern is about a week old. When the upper barrier is breached the rally should extend about the length of an average week range. Theoretically, the longer it takes for a pattern to take shape the further the trend will extend.

Determine Risk

The moment a position is taken the next move should be to set a physical or at least a mental stop loss. Trading is tough enough, so setting a stop loss may relieve anxiety, which allows the trader to concentrate on profit potential and trade management. Risk varies for all traders and may differ due to time frame of trade, account size, lack of conviction or fundamental factors such as earnings or economic reports. There are seemingly countless factors that can affect a trade.

The art of defining risk should include current volatility.

I refer to recent ATRs and percentages of them to project profit potential and risk. This approach allows me to be consistent with risk/reward ratios. For benchmarks I use 14-day, 9-week, 7-month and 5-quarter ATRs. A speculator or swing trader should focus on day and week ATRs. If you prefer longer-term trades use month and quarter ATRs to set risk and profit targets. One method I implement upon entering a speculative long position is to set a stop loss at 25% of an average day range below entry and set the first target at 50% of an average day range above entry.

Workhorse and Racehorse

I call this 2-unit system the workhorse and racehorse. Let’s walk through the steps for managing risk using ATR for a bullish swing trade.

When a bullish breakout is identified go long 2 units. A unit may be any number, but units should be equal amounts. For this example, buy 1 contract for the workhorse (WH) and 1 for the racehorse (RH) at $100
Average day range (ADR) = $4, Average week range (AWR) = $10
Long 2 @ $100

• Entry price plus 0.5 average day range (ADR) equals Target 1 (T1) or $102
• Risk/stop loss is set at entry minus 0.5 ADR or $98
• If T1 is reached, sell 1 unit (workhorse) for $2 profit
• Then move stop to entry ($100), now only the racehorse is active, if price reverses back to entry this unit will be a scratch trade, total profit $2
• If T2 (100% ADR) is reached, stop is moved to T1 ($102) to lock in another $2 profit if price reverses
• If target 3 (T3 = 0.75 AWR or $107.5) is reached, risk moves to T2 ($104).
• If T4 = 100% AWR or $110 is realized, stop moves to .25 ADR below highest price

Assume this trade is stopped out after T4 was hit. Workhorse +$2, RH +$9 for total of $11

T4 is the goal for my swing trades and that equates to an average week range. I recommend squeezing my stop if this target is hit because the goal has been reached and I prefer to retain more profit from the high-water mark.

John Seguin, Market Taker Mentoring