As a trend trader, using a moving average trendline, we don’t always think of risk clearly. We know that slower trends allow larger price swings without changing the direction of the trend. Faster trends respond quickly to price changes. Those risks are implicit in the use of a trend method and can’t be separated out.
One of the dilemmas of using a stop-loss to limit your risk to a “comfortable” amount can be shown best in an example. Suppose you’ve been following a trend system and you are long 1000 Amazon at $30 and now hold a $10 profit ($10,000 on your trade). You would like to protect those profits; therefore, you place a stop-loss at $28, risking only $2,000 of your gains. Sure enough, prices drop and you are stopped out. Prices continue down to $27.50, turn back up, and move above $40.00 to new highs. During the drop to $27.50 the moving average trendline never turned down. It would not have turned down until $22.00. You are now out of the trade but the trend is still up and prices are making new highs. What do you do? Do you jump back in and try to catch the rest of the upward move, or do you stand aside until there is a new trend signal?
None of these choices are good. If you going to trade the trend, then you must look at the risk in advance and decide how many shares you can buy and still hold the trade comfortably when prices move against you. A stoploss fights with the trend system. The trend system wants to stay long and you want to get out. It just doesn’t work.
You cannot trade more than you can afford to lose. Your position is too large if you are uncomfortable with the day-to-day risk.
One of the dilemmas of using a stop-loss to limit your risk to a “comfortable” amount can be shown best in an example. Suppose you’ve been following a trend system and you are long 1000 Amazon at $30 and now hold a $10 profit ($10,000 on your trade). You would like to protect those profits; therefore, you place a stop-loss at $28, risking only $2,000 of your gains. Sure enough, prices drop and you are stopped out. Prices continue down to $27.50, turn back up, and move above $40.00 to new highs. During the drop to $27.50 the moving average trendline never turned down. It would not have turned down until $22.00. You are now out of the trade but the trend is still up and prices are making new highs. What do you do? Do you jump back in and try to catch the rest of the upward move, or do you stand aside until there is a new trend signal?
None of these choices are good. If you going to trade the trend, then you must look at the risk in advance and decide how many shares you can buy and still hold the trade comfortably when prices move against you. A stoploss fights with the trend system. The trend system wants to stay long and you want to get out. It just doesn’t work.
You cannot trade more than you can afford to lose. Your position is too large if you are uncomfortable with the day-to-day risk.
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