Sunday, November 22, 2009

Q&A - Risk Management

Q. Jamie, Love your trades! You make it look so easy! I have a question for you in regards to risk management. I was also watching POT the other day for a break of 105 but didn't like the risk associated with taking the entry off of the 15min candle with a stop below that=94 cents risk. So I didn't take the trade. When price breaks such a major level like that are you buying the break of the level with a stop at the base of the 15min candle that's forming or are you dropping timeframe and managing risk off of the 5min candle? I know you like to see a candle close strong before entry.

A. There's no guarantee that we will get a NRB at the base prior to BO, so it's a good idea to size up the potential risk ahead of time. You can mitigate risk of loss in a number of ways. Here are two examples.

Option 1 requires looking for a mini base within the bigger base. This way you can possibly get a head start, and secondly, if the bigger base fails, you have time to scratch the trade and move on to something else.

Higher priced stocks frequently require wider stops. I like to look and the underlying price action of higher priced stocks such as POT, before committing money to the trade. Ideally, you want to see price and volume contraction during consolidation and expansion as price moves into the base. You can't see that on a 15 min. chart, so it's a good idea to drill down. Subtle hints on the 1 minute timeframe can often alter your confidence level in the setup.

Option 2 works well when the base is wide ie. price travels far to get to the base, so it has to consolidate shortly after the BO. But don't expect this to work on a tight narrow base. You risk missing the trade if you employ this strategy on a narrow base such as the handle in C&H pattern.

Q. I was also watching GS for a break of the 175 level but was uncomfortable with the risk that setup gave me as well. I did enter the break of the bear flag that day but missed my original entry idea because of the confusion as to where to put my stop. If price consolidates at a major level than it's not a issue where to put my stop but if price blows thru a major level and is extended from the last consolidation what's your stop placement rules on that scenario? Thanks.

A. I see the base at $175.50 as opposed to $175.00. The bear flag forms at gap support and the target is a gap fill. The setup is somewhat risky in the sense that it prints two dojis (indecision) prior to breaking. The bear flag is a pause prior to the attempt at a gap fill. If you don't see the whole picture and are unsure of the target, you are wise not to take the trade.


JTT said...

MY GS trade was planned off a higher timeframe and when the flag broke I was short at 173.43 and covered at next support level 172ish. (my fill=172.05). Stop placement-173.94. My original idea break 175(yes more like 175.50) was too far from the last consolidation and I'm glad I waited for the next consolidation area that presented a tradable pattern. I guess this trade falls under the Option #2:) I will be employing your stop methods in the future. Thanks for the detailed explanation.

Jamie said...

Welcome JTT