4 Trade Management Ideas based on 1 Dynamic Risk:Reward Strategy

Risk Reward of 1:2.5

Take as the basis of a risk management strategy that for 1 unit of risk, the trader aims for 2.5 units of reward.

There are several concerns to take into account over and above the 1:2.5 concept.

Spread

Firstly, the brokerage spread. Is this included in the ‘1’ risk – let’s assume YES it is.

Thus, our risk in the market is actually 1 unit minus the broker spread.

The 1 unit can represent any number of points.

For example, the matrix below shows 10 pips GBPUSD are risked in a long (buy) trade (including a spread of 1.4 pips).

ENTRY. 1.34560 (ask)
STOP LOSS. 1.34460 (bid)

This risk is therefore 10 pips of money, but only 8.4 pips of actual change in the exchange rate bid price, assuming the spread remains the same.

Note, in extremely volatile and/or illiquid markets, it is possible for the spread itself to widen to that 10 pips, which in a bad-case scenario, could cause a stop out withouth the price having even moved.

However, let’s assume for these purposes that the spread fluctuates, but is fairly stable, around 1.4-1.8 pips, averaging at 1.6 pips for the duration of the trade.

Why do I labour such a point?

Simply, because most traders do not think about it, and as a result, over the course of a great many trades, are not factoring in the amount of commissions (spread) paid out – the transaction cost of the trade.

Slippage

Furthermore, slippage should be considered. The slippage on the trade should be factored in as well. Let us therefore immediately allow for 0.9 pips of slippage when getting out the trade.

Therefore, we move our stop as follows.

ENTRY. 1.34560 (ASK)
STOP LOSS SELL STOP ORDER (BID). 1.34469 (BID).

Achieving the desired reward

To achieve the 2.5 reward mentioned, the target needs to be set at SELL LIMIT 25 pips ahead of the price.

Currently, 9.1 pips are at risk if we are filled by the broker at the desired levels, which ought to be the maximum at risk, under liquid market conditions.

The 0.9 pips of slippage would mean 10 pips at risk (including spread and an assumed slippage of 0.9 pips).

Let us assume that we will experience slippage and therefore go for 2.5 x 10 = 25 pips of reward on the trade.

New risk reward matrix

Therefore, we need to take profit (sell limit / exit / close) the trade at 1.6 + 25 + 0.9 pips = 27.5 points from the entry price.


ENTRY. 1.34560
STOP LOSS SELL STOP ORDER. 1.34469
TAKE PROFIT SELL LIMIT ORDER. 1.34835.

Example with money

Summary and development

Let’s assume now $10 per pip.

MAX LOSS is $100 (assuming maximum slippage is against us and 0.9 pips).
MAX PROFIT TARGET is $250 (assuming maximum slippage againt us and 0.9 pips).

NB. It is possible, with a good broker, that slippage can go FOR the trader – say a specified stop order is hit, and the price slips back down, creating less of a loss than was expectd, similarly a better profit can be gained from positive slippage. But we will always assume a bad-case scenario, with a view to better capital protection and higher profits over the long run.

With this trade set up and filled at the entry price, we can literally walk away and let the trade roll.

However, the conditions of and confidence in the trade might change.

Here are two ways the trade can be managed, which alter the risk reward, but also allow some profit taking, without ever risking more than the worst-case final profit target (once the trade management is instigated).

Assume the trade reaches 1.75 x the risk in the profit direction.

Trade management decision

A new decision is made along the following four lines:

(i) Probability of reaching 2.5 is stilled deemed EXCELLENT. Keep the original parameters entirely (10 pips risked, 25 pips aimed for as target). 1:2.5 risk to reward. No change.
(ii) Probability of reaching 2.5 is still deemed EXCELLENT, with strong momentum and one or more new swings in place above the entry. Bring the stop to break even + 0.9 pips (0 pips risked, 25 pips aimed for as target). Trade is now 0:2.5 risk to reward, we are trading with the market’s money and support below that is above our entry.
(iii) Probability of reaching 2.5 is still deemed GOOD, partial close.
(iv) Probability of reaching 2.5 is deemed OK, partial close.

Partial close scenarios

We will only consider scenario (iii) and (iv) in this post.

The following comes directly from the trading plan I use to manage my fund.

[CASE (iv)]
1.4.1.1. IF a 1.75 target is set and reached, but there is some probability of reaching 2.5 or more, then 0.75 can be closed at 1.75 and stop brought to BE+2, which would mean a 1:1.3125 risk reward +2pips if stopped out, or 1.9375 if goes on to reach 2.5 target.

[CASE (iii)]
1.4.1.2. IF a 1.75 target is set and reached, and there is good probability of reaching 2.5 or more, then 0.6 can be closed at 1.75 and stop brought to BE+2 which would be 1.05 risk reward + 2 pips if stopped out on remaining, or 2.05 if 2.5 reached.

CASE (iv)

In other words, 3/4 of the trade can be closed out at 1.75 reward (based on 1 unit of risk). The stop can then be brought up to say BE+2 (or BE+0.9 we have been working with as a less conservative estimate of bad-case slippage).

This leaves 1/4 of the original position in the market, with a bad-case loss of between 0-2 pips on the remainder of the position.

If this remaining quarter is stopped out, the final risk to reward of the trade becomes 1:1.3125.

If the remaining 1/4 position reaches the original target of 2.5, then the final risk to reward ratio of the trade will be 1:1.9375.

CASE (iii)

In other words, 3/5 of the trade is closed out at 1.75 reward, and the stop brought up to break even + 2 pips (to cover slippage and give an incremental increase to mitigate unexpected slippages on other trades, for example).

If this new stop loss gets hit, taking out 2/5 of the trade with effectively 0 pips profit, our risk reward ratio remains 1:1.05 for the entire trade.

However, if the original take profit is hit with the remaining 2/5 which is still trading in the market, then the risk reward for the trade is 1:2.05.

Conclusion

Thus, if 2.5 risk to reward is considered too high, the level can still be used as the final target, but a partial close will allow locking in of profits to create a minumum 1:1.05 risk to reward, and maximum 2.05 risk to reward, if closing out 3/5 of the trade at 1.75, or a minimum risk to reward of 1:1.3125 and maximum or 1:1.9375 if closing out 3/4 of the trade at 1.75 reward vs the risk taken of (-)1.

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A moving averages momentum trading system—trade management and forecasting.

Introduction

Continuing our analysis of the entry triggered by what we described in detail as a system for exploring the momentum of the market, using two timeframes and a set of moving averages, plus the Bollinger bands, part one being [click] here and part two being [click] here.

Stop loss placement and justification

The stop loss order is entered immediately on entry at 5390 as per the previous article, above the 88.6% (maximum) fib retracement of the entry candle on the H1 chart (level marked in red).

Entry timing and limit order usage

The entry at market is at the close of the H1 candle, NB it would be acceptable, and indeed professional, to place either a sell stop entry 1 pip below the close of the H1 candle, likewise a sell limit entry either at the 38.2%, 50%, 61.8% or 78.6% of the H1 candle, for even less risk, though in this case (actually a rarity), such an order would not have been filled.

Initial trade progression

After the entry, there is a dead drop, all seems wonderful.

However, the market is halted for 30 minutes what looks like the 61.8% level of the prior upswing (not marked).

This is followed by lower low, forming a lower high, lower low pattern, promising for our continuation.

Doji candle

There is then a doji candle, just to the left of the ‘E’ in the word entry marked on the above chart.

Lower high progression

Notice that the three candles including the doji and the two to the left of the doji, each have slightly lower highs.

Weak directional closes defined

There are then three upward facing candles, however, each fails to close much above its 50% level – for a candle to be considered bullish, really, we would want to see it closed in the top 25% at least – again a good sign for this trade.

Mini-swing correction defined

Thus what we have is the formation of a mini-swing correction, making up a rectangle potential energy building area, tested several times to the upside, followed by a new swing lower, consisting of three bearish candles,

Three black crows Japanese candlestick pattern

NB. This is also the ‘three black [in this case red] crows’ Japanese candlestick pattern.

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Confirmation of swing correction

The swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top as we just mentioned.

New swing establishment

The break of the low and close beneath it confirms the new swing is being established at the point of the close of the candle whose lower body and wick protrudes through the first red elipse marker

Stop management

The stop can then be brought above the correction high, effectively placed at the break even point.

Chart: 15 minute chart highlighting new swing low formation

Let us look more closely at the targets.

Fibonacci retracements and expansions

In the next chart, we have drawn Fibonacci retracements and expansions using the latest swing down (external Fibonacci retracements), off the back of the swing up before our reversal entry (alternate fibonacci retracements), and finally, by projecting a move that is precisely 200% of the recent upmove, from the top of the most recent pivot high projected downwards, i.e. from the high above the stop loss, to the low before the trade was placed, and beyond by 100% of that move, to include internal retracements.

See the section of the site on Fibonacci retracements, extensions, expansions, and alternate extensions for more information on these.

Price touch of lower bollinger band

As the price continues to drop, it finally hits the new position of the lower Bollinger band on the H1 chart, at 5350.

Cluster of fibonacci retracements/expansions

Thus, we can see a cluster of external Fibonacci lines, using both the most recent swing up which we are deeming corrective, and the most recent swing down, which we are deeming impulsive for the purposes of this trade.

Target of lower bollinger band with fib cluster

As can be seen in the chart, 4 hours after the entry candle, the price reaches the target of the bottom Bollinger band line on the H1 chart – the sensible first target given the sideways trading context on this timeframe.

Sensible flexibility on target

Since this level is 5350, even though the strict 1:2.5 take profit is 5348, it would surely be sensible to accept 5350 as level in itself that is likely to bounce (round 50), which is also the fibs triple cluster area as shown above.

Fib clusters described

Looking at the fib clusters (where levels are almost even with each other), clearly, the 114.6 fib of the most recent downswing is confluent with the 132.8 fib of the prior upswing, which in themselves are in alignment with the lower Bollinger band target – too much to ignore for the sake of a couple of pips.

Notice also how the double cluster of fibs above the ‘Fibs + BBand Cluster’ also acts as a line of symmetry for some choppy market behaviour.

Managing the trade with trailing stops

In spite of many clues pointing to 5350 being a sensible area to make like the wind with profit in our wings, the trade can still be managed using trailing stops as follows.

Aiming for fibs triple cluster

Management of the trade follows the lower timeframe, still aiming for the fibs triple cluster (2.5 x take profit), but locking in profits using a trailing stop method.

New swing low

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Correction high

As mentioned above, the swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top.

The break of the low and close beneath it confirms the new swing is being established from the point of the close of the candle whose lower wick protrudes through the elipse.

Swing trading stop management

The stop can then be brought above the correction high, effectively placed at the break-even point, as per standard swing trading rules.

The trade is now using the market’s money, with risk reduced from 12 points to 0 points.

Target reached

Just a few candles later, the target of the lower Bollinger band on the H1 is reached, and strongly rejected, hitting a triple confluence point.

Confluence zones

The first element of the confluence zone is the Bollinger band H1 lower line as we mentioned.

The second is the 132.8% retracement of the prior upmove, the third is the 114.6% extension of the prior downmove.

Such clusters form likely areas of reversal.

Trailing stop management of the trade

If the trade was not exited for whatever reason at the 2350 level, we are now sitting with a stop at break even, above the most recent correction high, using swing trading rules.

There is now a significant period of consolidation and thin liquidity, mainly due to market hours, which have not been considered thus far, and add to the reasons to have got out at 2350, or at the retrace to 1:2 as a consolation.

However, eventually, the market does create a new swing low as marked by the second red elipse.

At this point, the stop can be brought down to the level just whisker above the candle that did bounce off the original target of the lower Bollinger band, which has formed a correction high.

Eventually, this stop does get taken out at 5360, for a profit of 18 Nasdaq points, for 12 risked initially, that is to say, 1:1.5 eventual risk reward.

There are a number of alternative trade and risk management techniques that could have been employed by the savvy trader.

These are discussed at length in the sections on trading risk management.

Conclusion

In conclusion, we began in article 1 with a rules-based system for describing market momentum using averages, identifying potential reversals in the trend with filters (the Bollinger bands and 20SMA, plus the stochastic oscillator).

We went on to go through a worked example using an operational timeframe (M15) and a confirmatory, higher timeframe (H1) and traced the trade from start to finish, including stop loss, entry, forecasted projections and finally, trade management using either a confluence exit, or trailing stop.

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A moving average reversal, trend and momentum based trading system—example NASDAQ trade

Review

In the last article in this series, we introduced a way to establish intraday momentum on the M15 and the H1 charts, using only moving averages, with Bollinger bands for confirmation of viable trend exhaustion (a reversal).

Let us take the basic anatomy that we have explored and the trade that was identified on the NASDAQ cash index chart, and explore the follow on from that.

We suggested that given the matrix in the previous post, the downward bias can be clearly seen, with the full short term momentum signalling down on the M15 chart, and the first warning on the H1 chart.

Furthermore, recently, the price action had touched the upper Bollinger band on both charts, informing us of a possible trend exhaustion coming up.

Chart setup – M15 and H1

Here are the two charts as a reminder.

Chart 1 – 15 minute chart of NASDAQ cash index

Figure 1. NASDAQ cash index 15 Minute chart.

Signal candle

The signal candle for entry using the system we have built up is the last candle showing on the chart (close of the 1st candle in from the right).

The entry candle has offered a greater price change than any of the preceding 8 candles, and has closed very easily within its bottom 25%, it is a classic momentum down candle, closing also nicely below all three of our short term momentum averages.

Stochastic Oscillator

Notice also that a Stochastic oscillator (14,3,3) has been added and the main line is diverging away from the signal line, and both are pointing downwards, having just breached the 80 level from above, another good sign that we are on the right track.

The downward sloping longer term averages support the directional bias of the trade and add confidence to the entry.

One Hour Chart

Entry, stop and target price

On the one hour chart, we add the entry price, the stop and a 1:2.5 risk reward target to the H1 chart.

Bollinger bands sidways

We earlier noted that the H1 Bollinger bands were trading sideways, in which case, the bottom Bollinger band should be a serious candidate for a bounce.

Price should range between the bands in such a condition.

Entry candle from the one hour chart

Below is the entry as it looks on the H1 chart, the entry being the close of the rightmost candle.

The 3EMA ‘Elbow’

Note the acute elbow-like hook on the 3EMA, which forms our warning 1, given that it closes below the 5SMA on this chart.

One hour chart of NASDAQ cash index

NASDAQ cash index trading strategy

Stop loss

The stop is 12 Nasdaq points from the entry, including spread (5390 VS 5378, respectively).

This level is sufficiently tight, but still above the 88.6% retracement of the H1 candle, what I call the ‘point of no return’.

Alternative stop

An alternative stop would be just above the high of the H1 candle, but no higher, unless we were trading from an H2 chart, which we are not in this case.

Target risk reward level

The ultimate target of 1:2.5 risk reward is conveniently tucked below the current level of the Bollinger band lower line, which we believe will be hit in a sideways market, at level 5348.

We are therefore looking for the momentum to take the Bollinger band itself lower than its current sideways static level, as the market travels down, in order to reach this satisfactory risk reward area.

Trade progression

Following from our previous look at a trade triggered by confluent indications of a downward move starting from the M15 chart, leading the H1 chart and giving a high probability of reaching the bottom Bollinger band, after a reversal near the top of the H1 bollinger bands, sufficient momentum from the moving averages trading system described here.

Let us see the progression of the trade now, using the M15 chart and introduce some more advanced technical forecasting techniques, and visualise the risk management strategy.

Progression of the trade on the 15 minute chart

Complete trade evolution

The above chart shows the evolution of the trade from start to finish, using the operational timeframe, namely, the M15.

This article is continued by using some more advanced technical analysis and trade management techniques.

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Fast Track Pro Forex Trading Course: Limit Orders.

Trading using limit orders – complete EURUSD trading process example

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Freddy FastTrack
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VIDEO PRESENTATION

-BASED ON THIS POST (coming soon)

PRESENTATION HANDOUT IN PDF FORMAT WITH SPACE FOR NOTE-TAKING (opens in a new window)

Introduction

In a forthcoming article, we will look at market orders, whereby a quote received from the broker lends the trader a price at which to buy or sell immediately (the ask and bid prices, respectively) and we shall learn that such trades are traded in real time ‘at the market’.

In this article, we will look at another type of order, which can be placed in advance of the market reaching a particular price.

In other words, the order is set and the trader then waits for the market to ‘come to him’ or ‘come to her’.

In the worked example, from today’s live trading (28 April, 2017), the Euro US Dollar (EURUSD) pair was chosen – a popular, liquid currency pair with good momentum on offer during the European session normally.

There are 20 figures used as illustrations for this article, namely: figures A And B, and figures 1-18. To enlarge an image, simply left-click on it to view the image in more detail

What is a limit order?

The limit type of order is used for trading when the trader expects a reversal of the price at a chosen, designated level at which the trade will be opened, if and only if the price reaches that level or goes beyond it.

Limit order metaphor

A metaphor for thinking about the limit order concept is the price ‘reaching its limit’.

Once something has reached its limit, it cannot go further, and needs to come back.

Thus, if the market price of an instrument is going up, a sell limit will sell the instrument once it goes up to what the trader perceives to be its ‘limit’.

If the market price is coming down, the buy limit order will execute a buy trade when the price comes down to the limit order price.

Therefore, a buy limit order, is set at a price lower than the market is currently trading.

A sell limit order is an order set to enter the market at a higher level than the market is currently trading.

The contrasting pending order set are the ‘stop’ orders, a buy stop being a buy order in the upward direction above the current price, and the sell stop being a sell order below the current price. These will be covered again and again, and in detail in another article, so keep reading even if you do not ‘get it’ yet.

Hypothetical limit order example: DAX cash index

Let’s say the German DAX cash index (an index of Germany’s leading stocks) is trading at 19243.5/19244.5 with a spread therefore of 1 DAX point.

Most charting platforms will plot the price using either the bid price or the mid-point between the bid and ask price, that is the SELL price offered by the broker, or the average of the sell/buy prices, respectively.

Options may exist within the platform to show additionally the ask price, such as below in the Metatrader platform (figure A), whereby a line will be added showing the current ask price.

In Metatrader 4 trading platform, right click and select properties, or simply key ‘F8’ and select ‘show ask line’ under the common tab.

Figure A

The trader thinks that rather than entering the market now, the price is likely to retest a level such as 19235 (i.e. head down before going up).

Imagine that there is insufficient room, or confidence for the trader in this example to actually sell (trade) the market down to 19235.0 from 19243.5, but the trader does think that the 19235 level is a high proability candidate for a strong bounce, forecasting a catapulting of the price back up to the 19275 area, a move of 40 DAX points upwards.

In such a situation, the use of a buy limit order will allow the trader to get into the market at the desired price, with a preset order for the broker to execute, and a stop order that is fairly tightly below the support (in case the support fails, e.g. at 10 points below the entry, for a loss of 10 points in this event).

For example, the trade may place a buy limit order for a buy order to be instigated at 19236 (ask).

Therefore, when the bid price reaches 19235 (assuming the spread is equal at 1 DAX point), at that moment, the DAX will be bought at 19236, because the ask price will be at the buy limit order entry price, at which it will be converted to a market order.

Rather than entering the market with a buy trade at present time, a better bargain can be had by waiting to enter at a lower level. We will be looking at many trading strategies that will employ this risk reducing and profit increasing principle in this pro trader fast track trading course.

Trade planning in limit order execution

The buy/sell limit order allows the trade to be planned out in advance, not only the entry level, but the stop loss at entry and take profit at entry may also be setup in advance, in addition, of course to the position size.

The orders when placed for a sell limit and buy limit with pre-trade risk management parameters will be as follows:

SELL LIMIT (with BUY STOP LOSS [EXIT], BUY LIMIT TAKE PROFIT [EXIT])

BUY LIMIT (with SELL STOP LOSS [EXIT], SELL LIMIT TAKE PROFIT [EXIT])

Figure B provides a visualization of these four types of trade in metatrader and where they are supposed to be headed if used for entries.

limit and stop orders explained for trading
Illustration of buy and sell limit and stop orders

In both cases, the stop loss order and the [limit] take profit order both have the effect of closing the trade either at a predefined acceptable level of loss (the stop loss), or at the predefined acceptable profit target level (the [limit] take profit).

Full workthrough from today’s live trading

From today’s trading, we take the reader through a limit order using the Metatrader platform and trace the evolution of the trade in images and commentary.

Trade Idea

Figure 1. Trade Idea. Selling the Euro off a resistance level – M15 EURUSD candlestick chart

Figure 1 shows a EURUSD chart, the timeframe being 15 minutes per candle.

Rationale for limit order price point

Floor trader pivots (pivot points) show that the price has struggled to close above the mid-resistance 2 level, while the high of yesterday and the resistance 1 level have been clearly exceeded in a strong 25 pip upmove, likely to have resulted from news.

Assuming that the MR2 level struggle is a sign of the market being overcooked, a sell limit could be placed above the current price, with a stop loss at or above the current highs, and a suitably placed take profit, according to say, a risk:reward 1:2.5 or above trading rule.

It is also Friday and the end of the month, and we are not expecting huge ranges to be carved out, neither that the European economy is expecting a miracle today.

Furthermore, technically, the M15 chart shows clearly a normal reversal candle indicating potential impending weakness, and that candle is looking to close well within its lower 25% region, another sign that bears might take control for a time.

But this is only the 15 minute chart, so let’s await a retest of the MR2 to get a better entry to go short. A sell limit order will do the trick.

Figure 2. Setting up the sell limit order (1), by opening the order window.

Setting up an order in Metatrader 4

In figure 2, the ‘F9’ key has been pressed, or some other of several ways to open up the NEW ORDER menu in the platform, in this case Metatrader [4].

The current bid and ask price are revealed, and the type of order needs to be changed to ‘sell limit’ using the dropdown menu.

This is done in figure 3, below.

Figure 3. The pending order window set to sell limit in metatrader 4, with the EURUSD chart in the background.

Figure 3 shows the pending order being set up by the trader.

The volume shows the number of standard lots to be traded.

The stop loss allows a pre-defined [buy] stop loss order to be placed at the same time as the limit order is placed.

It is a buy stop loss, because once we are in the sell (selling Euros, buying US dollars in effect), we must buy back the Euros at a later exchange rate in order to realise a profit/loss.

Similarly when buying shares, one must sell the shares back into the market to realise a capital gain; it is as though the transaction pair is the share vs. the currency the share was bought in. It is an exchange transaction in the literal sense.

A take profit can also be placed (note that this is essentially a buy limit order, therefore at the ask price, which will have the effect of neutralizing the position and thus, have the effect of closing the trade).

Finally, on many trading platforms it is possible to add a timed expiry to the order, for example, after 15 minutes, or 1 hour, or whenever the trade is no longer desired if not filled. This will automatically delete the order if it is not filled at the expiry time.

Figure 4 shows what the chart looks like after the order has been placed. The – — – — dot-dash lines show the orders that are now on the chart.

The other lines are related to the floor pivots and the dotted red line just a visual tool to inform the trader of the price at which the high of the previous candle topped, and thus where to place the stop at or just above.

Figure 4. A placed sell limit order, with pre-defined stop loss and take profit (modifiable)

Risk management – stop loss, take profit and risk reward

The stop less (buy stop order) has been placed exactly at the high of the previous candle, plus 1.1 pips spread at 1.09488.

It is the ask price that will trigger the stop, since it is a buy stop order essentially.

When will the sell limit be converted to a market order?

The sell limit order is at the MR2 line, less the spread, at 1.09412 bid. A bid price of 1.09412 will trigger the entry.

The stop loss is therefore going to be 1.09488-1.09412 = 7.6 pips from entry, including an assumed spread of 1.1 pips, the current spread.

Initial take profit setting

The take profit order has been set at 1.0912 ask, just tucked above where the 8 simple moving average currently sits, 1.09412-1.09120, i.e. 29.2 pips below the entry price.

Note that the price shown in black highlights to the right of the chart is the mid price between the bid and ask, and that the take profit price in this case, refers to a buy limit order, therefore, the ask price.

For the take profit to be hit, the bid price therefore needs to reach about 1.09109 (1.1 pips lower – assuming this spread stays the same) for this buy limit (take profit order) to be triggered. It is the ask price that needs to reach the specified take profit level. Remember, the ask price is the brokerage price at which the broker will sell the instrument – it is what they are ‘asking’ for the instrument, therefore it is the trader’s BUY price.

The bid price is what the broker (and thence at least one other trader) is willing to ‘bid’ for the instrument. Therefore, it is the price at which the trader can SELL into the market.

Calculating the initial risk to reward ratio

The risk to reward then is 7.6:29.2 = 1:3.84 risk to reward ratio. We are willing to risk 7.6 pips in order to gain 29.2 pips at the outset.

Figure 5 shows the chart labelled manually, although these prices and the type of orders are shown to the left of the lines, out of the scope of the image.

Figure 5. The sell limit order with stop loss and take profit labelled.

Adjustments to the trade can now be taken, simply buy clicking on and then dragging any of the three lines around the chart.

Adjusting the take profit order (buy stop order)

In figure 6, below, the take profit has been moved up to 1.09211, or 19 pips from the entry price plus the 1.1 pips of spread, a more modest, yet still acceptable, 1:2.5 risk to reward ratio, with the take profit sensibly sitting just above the R1 resistance floor pivot point.

Figure 6. Take profit adjusted to a more modest level, but maintaining 1:2.5 risk reward

The trade has still not been filled at this point, though has come within 1 pip of being so. Everything is planned out in advance, so that we can let the market come to us, and let the trade take care of itself.

Figure 7 shows what the order looks like in the terminal region of metatrader, whose default placement is below the charts.

The order number has been obscured, as has the volume amount traded.

Figure 7. Order number, time, type, volume, instrument, price, stop loss, take profit and current price, for a sell limit order.

Figure 8 shows the tick chart from the market watch window, which shows the bid price being plotted tick by tick in real-time.

If the ticker chart ticks up 1.9 pips, then the sell limit order will be filled and the trade will be placed in the market, along with the stop loss and take profit orders earlier defined.

Figure 8. Tick chart alongside the sell limit order on EURUSD M15, showing the current bid price.

Sell limit order conversion to market order – order filled

In figure 9, the order has finally been filled and is shown in the terminal window, now with added columns, namely: commissions to broker, overnight interest paid (may be positive or negative depending on interest rate differential and the timing of interest payments overnight), and finally the profit/loss on the trade at present.

Figure 9. Order number, time, type, volume, instrument, entry price, stop loss, take profit, current price, commission, overnight interest and net profit/loss on trade (obscured).

There is nothing much more to do except for wait out the result of the trade and monitor the progress of the price action.

Evolution of the trade with the desired stop loss and take profit orders in place

Figure 10 shows the first evolution of the sell limit trade, now that it has been converted into a sell order that is already in the market, with its concomitant stop loss and take profit orders at -7.6 pips and +19 pips respectively, for a risk to reward ratio of 1:2.5.

Figure 10 EURUSD Sell limit trade now sell order in the market, with stop loss, take profit and risk management parameters (risk reward ratio shown by the red and dark green blocks).

Figures 11, 12 and 13 show the trade evolution over the next few hours.

Figure 11. EURUSD M15 chart 45 minutes after entry, with target areas marked

Triangle trading pattern

In figure 11, notice that a triangular pattern of consolidation seems to have emerged, being tested 4 times to the lower side, and twice to the upper side. This can be a continuation or reversal pattern, however, that this has now broken to the downside is a positive sign.

Quite soon after this breakout, after a similar mini-ranging movement, the trade then quickly reaches the 1:2 risk reward level (see figure 12).

Figure 12. Evolution of EURUSD trade triangle break

As figure 13 shows, after the break of the triangle to the downside, we now appear to be within another tight range, this time though, we can draw in the diverging wedge, using dotted lines here as each side, upper and lower, have only been tested twice, for a total of four times.

Furthermore, the lower side of the triangle from figures 11 and 12 is shown as an unbroken line, as it now becomes resistance, having been tested four times, it should support our sell trade.

Figure 13. Progression of trade with converging and diverging triangular/wedge formations

Figure 14 shows the trade almost completed, reaching the reward area to within 1.5 pips.

Notice also that the descending wedge lower line is just above the 2.5 reward area.

Figure 14. Edging closer to the take profit area of the 1:2.5 risk to reward trade

Intervention: trailing the stop up

For this reason, following the axiom ‘don’t let a winning trade turn into a loser’, we elect to bring the stop loss up to 1.25 of the risk, locking in a 1:1.25 risk reward, not optimal, but if the market decides this wedge is to catapult the price back up to the top, the trade would be back to where it started or worse, so this is a sensible option in this case.

Thus, the stop order (buy stop) is now the guarantor of a profitable trade, provided there is not some freak, very low probability instance of chronic slippage at or through that particular level.

Figure 15 shows the new [buy] stop loss order, which will have the effect of closing out the trade at a profit of 1.25 x the size of the original stop loss, but in (+)profit rather than loss(-) terms to the trading account.

Figure 15. Stop loss moved to 1:1.25.

The new stop loss, in its essence a trailing stop loss, because we are ‘trailing it down’ with the lower time frame swings down (kinetic energy movements), followed by smaller corrections up (potential energy gathering), is just a fraction above the high of the most recent swing correction and is labelled in figure 15.

The figure shows the 5 minute chart (incorrectly labelled as 15) to demonstrate the swing taking place at this lower timeframe, suggesting the stop is positioned reasonably, just above the most recent high in a correction within a series of downswings as just described.

Figure 16. Completion of the trade, and buy stop order (take profit) executed at 2.5 x the risk taken in the trade.

Figure 16, above, shows the completion of the trade.

Finally, almost 15 minutes after the stop loss was trailed to 1.09316, the market takes out the take profit level, providing the soothing 2.5 x reward to the risk taken.

Completion of the trade

The take profit (buy limit) order is completed, the details logged and the profit booked.

Here is what the completed order looks like in the terminal area of the Metatrader platform, figure 16, which is the penultimate figure in this series.

Figure 17. Order number, time of order, type, volume, symbol, entry price, [most recent] stop loss, take profit, time of close, price the trade was closed at.

Slippage

The astute reader will notice that there is a discrepancy as can be seen in terms of the take profit order (the buy limit at the ask price order in effect).

This required some investigation. We talked earlier of the level 1.09211 yet the trade was closed out at 1.09225. What happened?

Further investigation by way of examining the chart (and seeing the price action in real time), plus a simple call to the broker revealed the cause was slippage.

The volatility of the market, captured in some way in figure 18 below meant that even though the take profit was triggered in the right place, the best price we could get out immediately after the trigger was 1.4 pips greater than our desired take profit.

The remedy to this would have been to allowed 1-2 pips for slippage over and above the spread when calculating the risk to reward ratio.

As it happens in this trade, the market did continue down, so this would be noted in trade journaling as a point for consideration, because over 1000s of trades, that slippage is going to add up and needs to be dealt with by factoring in some kind of average slippage, or slippage factor weighted by volatility in the current market to neutralize it.

Figure 18. Volatility on the exit candle (3rd candlle from the right)

Figure Note. The long wick on the exit candle was a very quick bounce off the take profit area (marked in green), demonstrating that there was considerable profit taking or buy at market and limit orders around our take proft, to the extent we could not get an excellent fill on this trade, thus losing 1.4 pips to slippage.

On the one hand this serves to demonstrate we picked a sensible price to exit, but on this occasion so sensible that the rest of the market’s buying in the absence of sellers at that moment, created a small liquidity gap and hence gap in the price action, resulting in the slippage – the next available price to buy when the price reached our buy limit of 1.09211 was immediately 1.09226.

The broker took us out at that best possible price to buy once 1.09211 had been touched.

Summary and Conclusion

Analysis for trading journal

Final analysis: the trade was entered on the exhaustion of a Friday morning burst, with a sell limit at the retest of the MR2 (mid-resistance 2) resistance line, confluent with an H1 warning 1 (unreported). The trade was filled and a 1:2.5 risk reward trade was set up, with 7.6 pips risk. As the trade progressed and almost hit the take profit, to within less than 1 pip, the stop was moved to -1.25 x the stop loss ahead of the break even point. The trade went on to hit the -2.5 x stop loss reward area, but 1.4 pips were lost due to slippage. In the end, 7.6 pips were risked, and 17.6 pips made, for a final risk:reward ratio of 1:2.316.

Concluding remarks

In conclusion, using a sell or buy limit order is a more sophisticated way to manage the entry of a trade, allowing the trader to have greater control over the parameters of a trade, in advance of the pricing reaching the desired level of entry. The same goes for sell or buy stop orders, which are covered in the stop order article.

About the author

Dr Samuel Alexander Beatson gained his PhD from the Research Centre for Banking & Finance at the University of Nottingham in 2015. He has taught financial markets analysis for more than ten years, including during a two year position at King’s College London, as a researcher and fellow at the Lau China Institute. He is the head of trading and market analytics at Quantisi Ltd.

Freddy FastTrack’s FastTrackForex.com quote of the day

Everything is planned out in advance, so that we can let the market come to us, and let the trade take care of itself.

Top 3 Trading Moments from this trade

FREE PDF version of this article is available for saving or printing, click on the pdf icon below (opens in a new window).

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To cite any part of this article, use the following citation information: Beatson, Samuel A., "Fast Track Pro Forex Trading Course: Limit Orders.," in Forex, Commodities & Stock Index Analysis by Dr Sam Beatson, April 28, 2017, http://www.fasttrackforex.com/2017/04/28/pro-forex-trading-course/. Accessed online on December 16, 2017.

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