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The following information reveals a method to reduce risk by staying in good trades, but trading with small stops to avoid large losses.

Usage of stop-loss orders is normally critical to trading success. The most famous trader of all time, Mr. W. D. Gann, said repeatedly in his books and commodity course that it's always critically important to place a stop-loss order on each trade you make. That way bad signals and losing trades will not likely wipe out your trading capital, thanks to your stop-loss order giving you some protection.

Most systems and most trading methods require fairly large stop-loss orders. That is because stops are frequently based on one or more of the following logical (but frequently ineffective) methodologies:

a) Place a stop at a pre-determined percentage of the true daily trading range. For example, if the true daily range or average of recent true ranges (High minus Low, plus any gap between prior close and today's low or high) is say 83 points, then the stop may be set at perhaps 120% of that range or about 100 points. In the Deutsche Mark that equals $1,250.00 stop, plus any slippage that occurs.

b) Another method is placing a stop-loss just under the last swing-low or pivot-low. Note: A swing-low is a low point with higher prices on each side. For example, if last swing-low was at 10650 and price moves up for a few days to say 10750, then triggers a buy signal, stop may be placed just under the low price of the low day, perhaps at 10649. That also represents a risk of over 100 points ($1,250.00+). Of course, the reverse is applicable on a sell, with the stop being just above swing-high.

c) Use a moving average penetration as a stop, i.e., place a stop on a long trade at just under a simple moving average, perhaps a nine-day average. The trouble here is that if we entered long at about 7750, by the time the moving average is penetrated by the price, the moving average may be well below the market (due to its inherent lag-time), at 10600 or so. That results in a stop-loss at 10599 stop, and a risk of about $1,900.00.

d) Still another approach is to place a stop under last week's lowest price. This method may be even riskier because last week's low may be 10550. That requires a stop of 10549 or lower, and a risk in excess of 200 points or over $2,500.00.

e) Another simple and a totally unscientific approach is known as a "money stop." It involves setting an usually arbitrary stop based on either the maximum money you wish to lose, or stop based on a reasonable sounding number of points or dollars.

For example, psychologically you may not want to lose more than $1,000.00, so you set your stop at a price equaling $1,000.00 loss potential. That number is arbitrary, so it may turn out to be either too small or too large, depending on the volatility and the market involved. For example, perhaps it's too small a stop for T-Bonds when they're volatile, or too large when they are dull. If using the $1,000 stop-loss in the Corn market or another low-risk low volatility market, it may be too large a stop to use.

To read the rest of the report on commodity trading click-here!

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