A straight forward futures trading plan – The Wave part 2

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This is the second in a series of articles I will post on my futures trading plan. This post will focus on setting exit points. The first posting on entry points can be found here.

To refresh the Wave system uses a 2,10,30 day MA, with an ADX and %R confirmation.

My initial exit point would be my stop loss. There is some debate about the harm in both using a stop loss and not using stop loss protection. I will leave that debate to the experts, but for anyone starting out in futures trading, I think stop loss protection is a must, and I enter my STP order as soon as I am filled on my new position. The key issues is not setting the exit so tight that expected daily fluctuation will kick you out of a position prematurely. One of the great frustrations of trading is having your stop loss order executed by 1-2 ticks, to see 10 min later the contract retrace the loss and close positive for the day. But one also needs to define acceptable risk, and once that level of loss has been hit, exiting a trade per your plan is a necessary evil of a successful trading plan.

From a technical standpoint I want to close my long position when the 2 day closes below the 10 day. But I also want to make sure I am limiting my potential loss. Setting a maximum loss is part of a money management plan, and I while I will address money management in the future, some consideration of money management is needed for defining loss limit. Using a 100K account as an example, I would want to limit my loss on a given trade to 2% or $2000. This is also critical for defining position sizing; for me the two go hand-in-hand. For my calculation I am borrowing a technique attributed to the infamous Turtle traders. I am using Wilder’s Average True Range (14 day MA), which is in part a measure of volatility of price. Volatility of price defines expected fluctuation in price, and this is both helpful in determining position size and expected price fluctuation.

I multiply the ATR(14) times the value of a 1 point move in the commodity. In  AUG 2010, corn had an ATR(14) of about 12 with a $50 value per point giving a risk COFF of $600. That means if my corn contract moves down 12 points ($0.12 ) I will loose $600. But a STP of 12 would be too tight and would be hit too often, getting me whipsawed out of the trade. I like to examine a stop level that is 2X the ATR(14), so for corn in late SEP that would have been 24 points. On 8/4/10, The Wave gave a buy  signal on DEC Corn, and DEC corn opened at 413.5 in the late session, if filled at that price, 389.5 would have been the calculated price for a STP order, and this was also right around the 30 MA. But I would also pay attention to the 2 and 10 day MA, and any close when the 2 is below the 10 would be a warning sign, and the integrity of the trend would be in question.

I also use the ATR(14) for determining position sizing , and even if the contract is just too big or too volatile for my tastes. I will cover that next time and also how and when I adjust my STP order to protect my profits – if I was lucky and smart enough to have found a trend.

Always happy to hear from you --- tradesmith@att.net

Until next time… trade patiently, be profitable.


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