Thinking ‘Three Moves Ahead’ III

In Chapter Four of Three Moves Ahead, Bob Rice deals with the issue of time. He starts with the sentence: “Run out of time, and you lose. It’s the same in business and chess”. He could have added “and in trading”.

Pete Steidlmayer taught me that the greatest enemy to keeping losses small is trade location and time. I’ll consider trade location another day. For now, let’s focus on time.

In the trading world, we are usually taught to buy (or sell) breakouts and to protect the position with a price stop. While I do place a stop at a price beyond which I am not prepared to accept further losses, this is not my main exit tool. I exit using an assessment of the price structure and a time stop based on that time structure. In this way, I keep my losses down. Let me give you an example.

April is proving to be an ebb month – most of what I have done has resulted in a loss. In addition, even the profitable trades have only been marginal i.e. the profits occurred not because the market hit my price targets but because the trade management got me out with a profit. Had I not exited, those trades would have been losers.

So far, including two open positions, I have taken 15 trades for 10 losses. My total loss for the month (if my open trade stops were to be hit would be (2.7%)). If we exclude the open positions, my closed out losses amount to (1.19%). Of the trades closed out, only one trade would not have resulted in a stop being hit i.e. of the 10 losing trades, one would be open and no loss would have resulted.

My normal size stops average 1.5% of capital; but because I decided early that I was in an ebb state, I reduced my position size by 50%. So, in 10 losing trades, I should have lost 7.5% (10 x 1/2 x 1.5%). My profits have been 0.53%. So, without early exit, my CLOSED OUT net losses would have been about 7% (7.5 – 0.53%) – rather than 1.19%.

So early exit has made a big difference.

The key to early exit lies in assessing:

  1. what the market has to look like to stay in the trade
  2. what the market has to look like to exit the trade and
  3. whether the move against you is rotational or one-timeframe. If one timeframe, market exit is the key. If rotationa, the key is to assess an area (usually the point of control) to which the market will return to exit. Note that my entry price is irrelevant. The market neither knows or cares where you entered, it only knows its structure. Too many traders exit positions based on their entry. They should instead be looking at their exit relative to their risk.

Let’s turn to an example.

It looks as though the ES will open at 1403.75 and let’s say tonight I sell the ES leaning against the 60-minute open-gap rule, this setup carries certain setup assumptions and certain follow through ones.

  • My initial stop would be above 1426.75, basis June. (Above the maximum extension of my structure 1397.5 high, 1258 low)
  • In the first 60-minutes, the market should cover the open-gap i.e. if we open at 1403.50, we should see 1397 in the first 60 minutes. Because the market opens above Friday’s value area, there is only a 40% probability of a trend day down. Hence I’d be watching the volume configuration at 1397 to assess the type of market the day is bringing. If it is rotational, I’ll exit part of my positions (1/2) at around 1397 to 1395. I’d bring my stops above the highs of the day or 1406.75 whichever is the higher.
  • If the volume suggests a one-time frame day, I’d hold all my positions and have stops at scale out levels in case the one-time down reverses up.
  • At the end of the day, I need to see a close below 1384. If we close with a bearish candle but above 1384, I’d exit 50% of the position.
  • If the market fails to close the open-gap in the 1st 60 minutes, I’d exit the short position and re-assess. This would include whether to go long.

By asking the 3 questions daily, I find that the initial monitoring phase allows me to exit at a lower cost than the initial stop.

More on time tomorrow.

3 thoughts on “Thinking ‘Three Moves Ahead’ III”

  1. Ray,very interesting material.In regards to rule 3,i have found by noticing the time,direction and volume of orders,it can help to formulate whether to exit early or not and can give you a jump on the field.Some markets seem to have habits,even to the exact minute.Somedays however it does seem like someone is watching and doing their best to blow the stops.Paranoia is total awareness!!! cheers baz

  2. Baz

    It is also instructive to wait 60 minutes after pit session opens for ES to see eg whether it will close the gap, gap up or gap down.

    This first hour or even 90 minutes can tell us a lot which way the market is likely to go.

    Within the first 60 minutes, ES did close the gap touching 1397 and then rotate up with low volumes, yesterday.

    It indicated it would be non-trending; so I have my stops in and hit the sack before midnight (singtime), making up for lost sleep over these few days of watching the radar on ES at the 1400ish levels.

  3. Hi Baz

    Right! Certainly the markets I trade have time patterns that work a lot of the time; sometimes they don’t. That’s the nature of trading.

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