Let me tell you a quick story…
Once upon a time, an old man sells all of his goods for a large lump of gold, which he then proceeds to bury in a hole just outside his property.
He visits the spot every day, uncovering the gold, looking at it for a bit then covering it back up.
One of the man’s employees notices this odd behaviour and follows the old man. He sees the buried gold and when the old man returns home, the employee removes the gold and runs away with it.
The next day the old man finds his gold is missing and cries out in agony.
A neighbour hears the old man’s story and suggests that he place a rock in the hole and cover it back up.
“It makes no difference, does it?” the neighbour says. “You didn’t do anything with the gold anyway.”
One of our main aims in trading is capital preservation – as not losing money will eventually lead you to making money.
Limiting potential losses to small amounts of your account allows your winners to be bigger than your losers and hopefully, with a good win ratio, leads to profitability.
However, I don’t believe that enough emphasis is put on where to exit your trade.
Many traders concern themselves with where to enter a trade but neglect to think about their exit.
But I actually believe that where to exit your trade should be at the forefront of your mind when placing your trade alongside entries and stop placements.
After all, your exit determines whether you have made or lost money, so ignore it at your peril.
I admit; I used to be a victim of being far too ambitious about my price targets.
I used to want to go for trades that had reward ratios of four upwards.
But the problem with this is that yes, it’s great when they come off, but in reality trades with that large a risk: reward ratio either:
a) Tend to have too tight a stop and so it’s easy to get stopped out…
b) The take profit level is outside of the market structure. The price hits a level and reverses, leading you close the trade for a smaller reward (which messes up your expectancy on the sample).
c) Reverses and hits your stop completely, leading to a loss. This is less preferential, but actually teaches a better lesson, since you adhered to your risk management throughout the trade.
Your psychological approach to trading the markets should always be to minimise risk, whilst maximising reward.
To do this you should combine risk management with market structure.
Here is an example on Tesla (TSLA):
Click image to enlarge.
What you want to do is consider support and resistance levels as magnets.
One magnet repels (your retested level where you execute your order) and the other one attracts (where your take profit should be).
However, you want your take profit always to be within the market structure, and your stop loss to be outside of the market structure – as you can see from the image above (the green and red shaded areas on the chart).
Why?
Because you don’t want the market to miss your take profit level, but you want to let the market breathe with your stop loss level…
Otherwise you could get taken out easily on a trade that could have worked.
Remember: The support/resistance market structure acts as magnets until it doesn’t… in which case a new structure is formed based on new market beliefs and new levels of interest.
This is why I consider support and resistance to be the foundations of any trading strategy.
In fact, trading purely support and resistance can become a strategy in itself, provided you are able to understand other market factors surrounding it.
As ever, if you have any questions on this please hit reply and let me know.
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