The More Intelligent Trailing Stop
- Trailing Stops can reduce risk but increase the chances of being stopped out prematurely.
- Manually trailing our stops each time there is a new swing high/low reduces this whipsaw effect.
- An Asymmetrical Fractal can provide guidance on when to move our stop.
During my simple strategy webinars, traders often ask me if I use trailing stops. When I tell them that I manually trail my stops, it is usually followed by several seconds of silence. It’s not that I don’t think people can be successful with traditional trailing stops (there are many successful traders that do), but for me personally, I like to set my stops around support and resistance levels to reduce my odds of getting stopped out.
This article will discuss the issue I have with traditional trailing stops, how I personally trail my own stops, and a handy tool to make this method extremely simple to follow.
The Flaw in Trailing Stops
Trailing stops are a more advanced type of stop loss order that adjusts itself to a more favorable rate as a trade moves in our favor. The result is a reduced stop loss (reducing risk) that is based solely on how price moves. It is at that moment that a traditional trailing stop shows its flaw. The stop moves to a level based on how far a trade moves in our favor, rather than moving based on key price levels. All support and resistance analysis previously performed is thrown out the window as our stop moves freely to a random level X pips away from the currency pair’s high water mark.
Therefore our stop we set beyond the most recent swing low will suddenly move to a level above the swing low and be at much greater risk of being hit by a sudden downward whipsaw.
Learn Forex: Trailing Stop Getting Whipsawed on USD/CNH
(Created from FXCM’s Marketscope 2.0)
Manual Trailing Stop
So what can we do about trailing stops’ tendency of getting stopped out too early, but still have the benefits of reducing our risk during the life of our trades? The secret is in manually trailing our stop losses ourselves, always basing our stops around support and resistance levels along the way. A rare example of having your cake and eating it too. Let’s take a look.
Learn Forex: Manual Trailing Stop in an Uptrend
The image above shows the same trade we placed on the USD/CNH, but with much better results. Rather than using a traditional trailing stop that blindly moved up as price moved up, we moved our stop only when a new swing low was created. We set our stop below each new swing low as price progressed and were able to ride this monster uptrend 1500 pips before being stopped out.
It can take some time to be able to “eyeball” significant swing highs and lows and know exactly when a stop should be moved. Therefore, try out this handy tool that does all the hard work for us (see below).
The Asymmetrical Fractal
A fractal is a tool that draws an arrow on each candle that’s highest price is higher than the high of the two candles to the left and two candles to the right. It also draws arrows on each candle that’s lowest price is lower than the low of the two candles to the left and two candles to the right. It can be used to note potential turning points in the market, or in this case, can be used to identify swing highs and swing lows that we can base our stop off of.
We can find Fractals on Marketscope under Indicators, but I like to do a bit of customization that makes it more relevant to manual trailing stops. To do this, we need to download the Asymmetric Fractals indicator on this page here. Save the .lua file and drag and drop it on your chart to automatically install it inside your indicator folder like seen below.
Learn Forex: Downloading & Installing the Asymmetric Fractals Indicator
Once installed, load the indicator just like any other indicator. Then, we want to select the following settings:
These settings will create less fractals than the traditional version due to the stipulation that the candle’s high or low price must be higher or lower than the previous 5 candles and the following 9 candles. Now that we see the asymmetric fractals on our charts, we can see their value immediately. Each time we see a fractal, that is a level where we could manually move our stop since it is a significant swing high or swing low. I’ve overlaid our fractals on to our USD/CNH chart used earlier to show how our manual trailing stop moved almost 100% in sync with the fractals created over the same period:
The Buck Stops Where?
Hopefully, this article has given us a better way to trail our stops. We always want our stop to be beyond the most recent swing high or swing low, and the asymmetric fractals can help identify those levels. Do you have a demo trading account with real time charts to practice manually trailing your stops? If not, you can sign up for a free FXCM demo account here.
---Written by Rob Pasche
To contact Rob, email email@example.com.
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