Dave Landry On Laying The Foundation For Successful Swing Trading, Part II

Placement of the initial protective stop is as much of an art as it is a science. Too close and you will almost surely guarantee yourself a loss as the “noise” of the market will stop you out. Placing it further away will increase you chances of a winning trade should the trend resume, but obviously increases your risk if it doesn’t.

When trading pullbacks, the low of the pullback is the obvious place for a protective stop. However, because this is common knowledge, it becomes a target for market makers. Therefore, I like to use a somewhat looser stop (especially if the low of the pullback is fairly close), taking into consideration the volatility and price of the stock (higher priced/more volatile stocks require a looser stop).

The following table is a general guideline for where initial protective stops could be placed (from the entry) based on the price of the stock. This should help to keep you from being stopped out prematurely. Keep in mind that tighter stops can be used on less volatile stocks. Conversely, more volatile stocks will require looser stops

Stock Price Protective Stop (amount risked)

$10-$15 $1

$15-$20 $1-$1.50

$20-$30 $1.50-$2.00

$30-$50 $2.00

$50-$70 $2.50

$70-$100 $3.00

$100 $3-$4

Money Management

Initial Profit Taking

On most swing trades, the profits will be small and have the potential to quickly erode. Therefore, as soon as your profits (a) are equal to or greater than your initial risk (b), you should lock in half of your profits and move your protective stop on your remaining shares to breakeven (c) -- (near your original entry).

Locking in half of your profits and moving your stop to breakeven when your profits are greater than or equal to your initial risk, will help to generate income for your account. This income will help to pay for the inevitable small losses associated with swing trading. Further, barring overnight gaps, this gives you, at worst, a breakeven trade and a chance at a home run on the remaining position. Larry Connors, in Connors On Advanced Trading, has dubbed this simple, yet effective, form of money management 2-for-1 Money Management.

Keep in mind that this is just a basic money management system. You can (and should) build from here. Also, conditions will help dictate where profits should be taken. For instance, in strongly trending markets where the sector and stock are also in gear, you might look to let profits ride a bit on the first loaf after the profit target is hit (e.g. trail a stop intra-day on the first half). Conversely, in choppy markets, you might look to take profits more quickly and move you protective stop to breakeven.

Trailing Stops

Stops can be trailed higher on a point or pattern basis. Using a point basis, one would simply follow the guidelines outlined in the table on page XXXXX, provided of course, the volatility of the stock is taken into consideration. For pattern based trailing stops, one could place their stop beneath support levels or beneath recent lows. For instance, placing a stop below a two-to-three bar low can often catch the majority of a strongly trending market.

My goal with every swing trade is to have it turn into a longer-term play. Therefore, if I am fortunate enough to capture a short-term move in a stock and have already taken partial profits, I will trail a somewhat looser stop on the remaining shares. Ideally, this will allow the stock enough room to have and orderly correction (or form a base) and then resume its uptrend. Each time a stock the stock does this, I then tighten to the level of the last base/correction.

Good luck with your trading,

Dave Landry