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A market that is trending up should have higher peaks and higher valleys. The majority of bars should also have higher highs and higher lows. In a down trend the market should have lower valleys and lower peaks and the majority of bars should have lower lows and lower highs.
When a market is in consolidation (bracketing/flat) the price will generally oscillate in a broad range. Traders who are watching for the breakout will monitor the security for a qualified break. They may place a straddle traded to catch the move regardless of whether it breaks up or down.
There are traders who specialize in trading consolidation. I don’t however recommend it to new traders simply because they get whipsawed too much.
A stop loss is the level at which you will close a trade on the basis that it has gone too far in the ‘wrong’ direction, and therefore negated the reason for being in that trade.
Always use a stop loss when trading; it can be too easy for a $300 loss to become a $5000 loss. A good trader takes a small loss and goes on to the next trade.
Remember that trading capital is your business; if it burns there is no insurance. Once you have entered a trade immediately place a stop. This safeguards you from losing your entire account.
It is also wise to talk with your broker about how they execute your stop. Some brokers execute stops differently.
Your stop loss policy can be set in a number of ways. Some use an actual figure (e.g. $100), and some a percentage figure i.e. they do not want a position to go more than a certain percent, say 5%, against them.
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Others may use technical analysis principles to set stops. This is my preferred method of trading. If I enter a trade on the short side after a signal, as in the example below I will place my stop in the next nearest resistance.
The opposite is true for the long side. If I enter a trade from the long side I will place my stop at the next lowest support.
It’s important to insure that your stop is canceled if you close your position. I mention this, as you would not be the first trader, which closed a position only to forget that they still had a stop in the market, which would take you back into a position.
The most important thing, however you approach the decision, is to know where you will cut a losing position before entering the trade. Set the rules and ALWAYS follow them.
The stop loss means that if a security trades a certain amount below or above where you entered the market an order is executed to close your position.
You may use “programmed” stops if your broker offers them. (Some brokers do not offer this.)
You can also at anytime during the trade close the trade by calling your broker or executing the trade on your dealing station.
If you are long a security you will sell it in order to close it. If you are short a security you will buy it in order to close the position. Think of it like this, when you buy something you now own it. In order to get ride of it you must sell it.
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