Trade Management Rules & Values

As I said in a previous post, to obtain profit from a trade, you either have a take profit set, or you gradually move your stop loss to a position of break-even (if you want), and then to positions above your initial entry.

When you are relying on the stop loss being moved above the initial entry point, that's where Trade Management Rules come in. As with everything else, I believe they need to be explicit and objective.

In the example trading systems I gave, you'll notice the Trade Mgmt Rules I gave were something like:
Long - S/L Mgmt Rules: Every Bar

And the Trade Management Value was (for example):
Long - S/L Mgmt Values: Low Of Previous 50 Bars

If we are trading a system manually (i.e. no computer involvement), then the rule for setting and moving the stop loss would probably be written something like "The stop loss is, and remains at, the low of the previous 50 bars".

But when you're making a computer do this for you, it must be specified exactly what that means. And what it means is "every bar calculate the low of the previous 50 bars. Use that as the new value of the stop loss". So I made a "Every Bar" rule, which of course evaluates to "True" at every bar. Without it, the stop loss would be set initially, but wouldn't move after that.

Some systems have more complicated Trade Management Rules than that. For example, and assuming of course the period and standard deviations for the bollinger setup are specified, "When the price closes above the upper bollinger line, move the stop loss to the value of the upper bollinger line". In this case, the Trade Management Rule is "close is above upper bollinger line", and the Trade Management Value is "the value of the upper bollinger line".

A close above the upper bollinger line isn't going to happen all that often. But when it does, this system is going to move it's stop to the value of the upper bollinger line. Given that there aren't too many bars that have their low above the upper bollinger line, that trade would probably get closed out the following day, but this is just an example.

Now, while I haven't exactly been thorough on Trade Management Rules and Values in this article, because the possible rules to pick from would be a lot like the Entry Rules and the possible values a lot like Entry Values, they are very, very important.

This is, after all, how we decide when to exit the trade. And exiting is when the profit is made, regardless of how we got in the trade in the first place.

There are some people who believe spending a lot of time on the Entry Rules is futile, that even random entries would work, because it's all in the exit. The thing about systems that you buy is that they focus mostly on the entry. Personally I think it all adds to your probability of success, but certainly the exit is where it either fills your wallet, or empties it.

You enter long and the price goes higher. Do you sell now? Is the price going even further, or is it about to turn around?

You enter long and the price goes lower. Do you sell now? Is the price going even further, or is it about to turn around?

Guess-work. It's why you need a solid trading system, proven over a long-ish period (which varies depending on the timeframe you trade), with clear, objective rules.

When you enter a trade and the price goes against you, that's where your stop loss comes in. You've already set it, hopefully, at a spot where you decided that if it went there, you are prepared to admit you got it wrong this time and take the loss.

When you enter a trade and the prices goes in your favour, your Trade Management Rules now specify when to move that stop loss to lock in some profit. When we set the stop loss initially, we gave the price some wiggle room. Because the price wiggles. We have to keep doing the same thing when we move the stop loss. Set it relatively close and yet relatively far.

And therein lies the problem. Exactly when and where to move the stop loss? Here's where experimentation and backtesting comes in. Buy some of those $49 systems to get some ideas. Try them out. Add rules of your own.

By this time you should have everything needed to specify entries. Look on the chart to see what normally happens after your system entered a trade. If the price continues on in your favour, then retraces 20 pips, then goes on, then retraces 20 pips, then you can't move your stop loss closer than 20 pips away from the price.

If the price seems to always retrace through the 0.382 fibonacci retracement level before heading further north, but it hardly ever breaks the 0.618 except when it's a reversal, then it stands to reason that your stop loss should be just below the 0.618 fibonacci level and not the 0.382 one.

And this is why your Entry Rules can't be random. Because probably your Trade Management Rules are going to change based on what normally happens to the price after you've entered. Random entries aren't going to allow you to work this out.

So, backtest. Experiment. Work out when the price is *most likely* just retracing before continuing on, and when it's *most likely* reversing. Difficult to do, but a worthy task. And then tell me :-)

About Stop-And-Reverse Systems
I've completely neglected this kind of trading systems, sorry. That's where your system is always in the market - if it's not going long then it's going short. In this case you wouldn't need either a take profit or (stricly speaking) rules which move your stop loss.

But, I include to "Exit At Market", which is what you do with your long trade in the stop-and-reverse system when you want to go short, as a Trade Management Rule.

Sure, in forex, if you have 100,000 going long, you could purchase 200,000 going short, which would effectively close your 100,000 long and leave you with 100,000 short. But I prefer to keep my trades distinct.

And so if I create a stop-and-reverse system in my software, I set the entry rules for going short to match exactly the Trade Management Rules of the long, and vice versa, with the Trade Management Value set to "Exit At Market". That way the long trade is closed, and the new short trade is opened.