My 11-year-old son plays for our local village football team. I’ve watched him, and his teammates, play since they were about 5 years old, when they were just a mass of oversized blue shirts all crowding around the ball, desperately trying to get a touch.
These days, it’s great to see those same kids looking for space and trying to predict where they need to be moving to. Although I do still catch them sometimes gazing into space, doing a floss, or just picking their noses.
Moving the goalposts
Being able to adapt what you’re doing to the changing environment around you takes practice, and the faster things are moving around you, the tougher it is.
This is exactly what traders are doing in the markets.
Adjusting your trades ‘on the hoof’ can be problematic.
It can involve making fast decisions, often under pressure.
Perhaps a trade is losing badly – should you cut and run, or watch and wait as the market moves towards your stop?
Or perhaps you’re showing a good profit, and you’re nervous that the market is retracing? Should you take those gains off the table while they’re available?
It’s exactly these kinds of situations that bring out the worst in us as traders.
The beauty of trading with a fixed stop distance and profit target means that we can walk away from our screens and not get tempted into any bad behaviour brought on by ‘emotional’ trading.
But there is another way … a way we can dynamically adapt and shift with the market, while still keeping firm rules and discipline.
I’m talking about dynamic trading levels.
Dynamic levels don’t just sit there, waiting for prices to come to them. Instead, they’re watching what the price is doing, and they are reacting and repositioning themselves all the time.
These are the levels we can look to for closing trades early by adjusting stop levels and profit targets, or even leaving trades to run for longer, as a the stop level trails behind it. Here are some examples …
Moving averages often act as levels of support or resistance when the price is moving in a trend.
This can be a great tool to enable us to move a stop loss tighter, locking profits as the price moves in our favour.
In this example taken from a 4 hourly EURUSD chart, the 20-period moving average contains the downward-trending price as it repeatedly bounces off this level …
Bollinger bands are based on standard deviation, which means that they give us an inside track on how far a particular market usually moves. This is just the kind of information we need when positioning our stops and targets.
There’s no use having a profit target that’s way out of the predicted range of a market. Nor a stop level that’s so tight it’ll be knocked out by casual wobbles in the price.
The Bollinger band creates a channel where we can expect the price to move. If it comes out of this channel, then it suggests that external fundamentals are driving the price, and it could be that our initial signal is no longer valid.
Bollinger bands are at their best in a range-bound market. In a strongly trending market, they can be broken for extended periods. In the example below, we’re looking at a 10-minute chart on EURGBP, where you can clearly see the range-bound overnight trading bouncing neatly between the Bollinger bands. The morning session kicks off with a strong upward trend, which immediately breaches the tight range of the overnight session.
The parabolic SAR has long been used by traders as a dynamic trailing stop loss. As the name suggests, this is where the market is ‘predicted’ to ‘stop and reverse’.
The parabolic SAR appears on charts as small dots or lines running above or below the current price level. If the price is trending upwards we expect to see these markets below the price, where they could be used as a useful stop level. Conversely, if the price is trending downwards, the parabolic SAR will appear above the price, again offering a potential level for positioning your stops.
Another stalwart in the armory of trailing stops, the Donchian channel marks recent highs and lows. It may not be a very sophisticated technical indicator but it is very easy to use and is well worth considering if you want to automate the process of using recent highs or lows for a trailing stop on your trade.
You can adjust the frame of reference for your Donchian channel. The default setting will be to mark up the high and low of the previous 20 candlesticks.
As you’d expect, this method is at its most useful in range-bound markets, where a breach of the recent high or low marks a signal to exit a trade. In a trending market, the Donchian channel can provide a useful trailing stop level, but it can be relatively slow to react.
Sometimes, no indicator can beat a channel drawn in by hand.
Rising and falling markets don’t move in straight lines, but their ‘wobbles’ can sometimes be reliably mapped between two parallel lines …
Putting it into practice
The great thing about these tools is that they allow us to adapt and change our open positions, without giving in to whims and those rushes of panics we feel as profits ebb and flow.
Of course, dynamic levels are responding to price changes, so we need to beware that we’re adapting to price changes to curb our risks and maximize our profits, rather than letting price changes dictate to us.
In practical terms, this means that dynamic levels can go up and down, and I’d urge you to be disciplined about not widening stop distances, even if the dynamic levels are widening. Using dynamic levels can help to improve the risk-reward profile on our trades, as losers are stopped out sooner, and winners are allowed to run. They should NOT be an excuse to lose our grip on risk levels.