11
 CLG DAILY 1941
+h| ra '
My
1cert te hynissed on the gap i, iopen. We vill try riagain on the next bar. | le
P
  
CLG DAILY 1912
Hyat
itll,ft this ipoint our if
{entire MF tion {should be in Place \
if ‘y,ull ft
 
46
42
CLG DAILY 1933
2368
zs20 th
2280 pe k,
2240
2200 hil,2160,
2128 This bar hy 4peso Uings a fill “ifzea "ear the close2000 Ve will try for196@ another fill below
1888
oc
CLG DAILY 1852
23682328
2248226821682128288820482000196819201880
 
tty2280 u! k,
need a sell astop belou theRhif our entireposition is inplace.
lt,
ly,
1920 the low of the last bar:
 
 
2368232822882248220821682128208820482088196819281888
2368232822882248220821682128208820482000196819281see
Charts 40-43. An adequate trailing stop would have kept us in
the market throughout the four days shown on this set of charts.
We would have been able to build our position by adding on.
112
 
cL GCLG DAILY 1878 2373 DAILY = 1897
ty 44 2325 th,
1. 2275
ly thy 2225 ‘, ih
2175
2125 hy HH
%
2075282519751925187518251775
siienitibeiilNOU
 
NOU
These are the last tuo charts in this series. It renains to be seen how longthe dountrend will continue,
  
Chart 44, Here ve see a reversal day. By now you should know that it usuallymeans sone sort of correction is due,
Chart 45. Sure enough the market corrects, We vould start trying to sella breakout of the correction lov. We would also place a sell stop below
the Rh for part of our position.
Renenber, it is up to you to decide hov much of your position you vant toplace at any given level. [t is a matter of comfort and style, Where doyou fee] best about placing your entry stops?
 
Now | want to give you an additional concept which can bestbe shown by some illustrations. It involves the very situation thatcaused me to begin seeing the hooks in the first place. It embracesthe concept that you can't always identify the number 1 point of a1-2-3, and yet you don't want to miss the "pointy” place in themarket.
 
You can count these next charts as part of what | have termedconceptual processes in Chapter 7.
113
21252i
197:1925187;182)177Hooks and 1-2-3'sTake a look at the following chart.
DA-H.S MINHere we have a five minute D-Harkchart showing an opening gap.
It doesn’t matter about the tineframe, it’s what ve see that counts. |
This could just as easily have ibeen a daily chart. h
The problems is in kidentifying whatwe are seeing. | t
Mah
‘
t <- gap opening.i
ft
    
18 11
 
How do we identify the difference between a 1-2-3 formation
and a Ross hook, in relation to the gap opening?
114
 
6248
62286224622862166212
62846288619661926188618461886176617261686164616861566152614861446148
 
At times it is difficult to see the number 1 point of a 1-2-3. Isit important to see and be able to identify the number 1 point? Theanswer is no. What is important is, that even when we are not sure
where to place the number 1 point, if we can identify progressivehooks, we know we are in a trend and should be willing to"mechanically" take a breakout of that hook, or sooner, if possible!
DM H.S MIN
Do we have a 1-2-3 followed bya Ross hook?
 
DA H.S MIN
Should we have marked the chartas shown below?
Does it really matter? f i
 
115
61686164
614861446148Do we also need to take into account the fact that thiscommodity trades overseas during the night while the markets areclosed in the United States? The answers are that it doesn't matterwhich way we mark the chart, nor does it matter that thecommodity traded overseas during the night.
DA H.S MIN
The important thing is that themarket is making progressively th
higher highs, and new Ross hooks. 6224He 6228
if pet ‘,. =
iy
Let’s analyze what this marketwas doing, and how it mighthave been traded.
h “|
6188i it Le Ml tl I 6184, Hf Follow along on the next couple 6188Hh of charts to see what I did. tioeThis illustration is from an ere
actual trade I made in theD-Mark. 6168
                    
DM H.S MIN
In addition to the highs being 6236higher, the lows, too, are higher. -
Although I don’t normally
recommend it, I took the first
breakout from congestion Hfbecause it was taking out a 1third progressive higher high.
I would have attempted it evenif it were a secondprogressivelyhigher high.
On this first trade, I was able to 6168cover costs on one contract set, and
take a small profit on a second 6176contract set. I was stopped out of 6172wy third contract set with 1 tick of 6168slippage. 6164
116
 
Dn H.S MINKen nce eo gems natet ealthat same point would constitute 6z32a socond-time—through breakoutof congestion. I took the trade |as shown. Hl i in , Ih 6228)ruhigher lt Ht \, l| i coathigher l, ft i}! 6196higher ty hy iF I entered = this ben as 6188fg ML eee ieee OF Sa one oiemien | Ht Seinea’s second Sotrect sci for ivealt profits az prices took out the 6172i] fe 4 4 last highor high marked on the 6168, | kh} Sot on the spike highest high, when 6164Ine T I gay that, it was going to close in oielower ° range.I was through trading, and was happy to have my piece of the market. 6148I wasn’t oven around to see the down move later in the day. 6144
 
For better or worse, this is the way | trade and this is the way |think. I've pretty well automated my reactions to what | see in themarket. For instance, the cashing of a second contract set forprofits as prices took out the last higher high marked on the chart,shown above. This was an intermediate profit objective for mebased upon my previous entry. | almost always enter anintermediate profit objective order as a resting MIT order at thenumber of ticks | wish to take out of the market. In the case above,it happened to coincide with the higher high. If | see any sign ofreversal as | watch es progress, | mmediately go to themarket with all remaining contracts. | can always attempt reentrylater.
  
| know that getting in early when possible is the best way toenter breakouts. | also know they work most of the time.
117Another thing | know is that | have extremely fast reactiontimes, and can therefore dare to take first time breakouts. Butunless both you and your broker are very fast and have excellentexecution on the floor, you must wait for the second time through.It means you will miss some trades, but better safe than sorry.
It's time now to give some serious thought to stop placement.The next topic will be quite lengthy. If you feel that you would liketo read it completely through, this might be a good place to stop fora break. Get something to eat, take a nap, or do some exercise.
 
When you come back get ready for some in-depth materialabout stops.
118
 
 
Chapter 10
StopsWhere Do You Place the Stop?
Stop placement appears to be a topic that is on every trader'smind. Where do you place the stop?
In this chapter, we will consider four situations for using stops:
1. Mechanical Stops: As dictated by mechanized tradingsystems.
2. Protective Stops: To protect against loss, or to protectprofits.
3. Objective Stops: To cover costs.
4. Entry Stops: To initiate a trade.
5. Exit Stops: To terminate a trade.General Considerations
At various times you will hear or read material from someonewho tells you where to place a protective stop.
Of course, if you are following an adviser and taking thatadviser's trades, you must utilize the adviser's stop placement.Why? Because when you follow an adviser, you are trading amechanical system. The adviser is your system. You cannotpossibly expect to achieve success until and unless you do exactlyas the adviser dictates. In addition, you also need to do a lot ofpraying. Pray that the adviser will have a good year in the markets.
 
 
119The same consideration is true if you follow a mechanicalsystem. If you expect to get the results you paid for when youpurchased the system, you must place your stops as the systemdictates. At times, the draw down against your margin will bevirtually intolerable. That's the price you have to pay for trading amechanical system.
There are few traders who can maintain the discipline neededto exactly follow a mechanical system, whether it be computergenerated or derived from an advisory of some sort.
| will have a few more words to say about trading mechanicalsystems a bit further ahead.
Should you place a stop at a certain number of points distantfrom current price action? Should you place a stop at a certainpercentage distant from current price action? Or, should you place astop a fixed money amount distant from current price action? Anyor all of these may be an incorrect way to place stops.
| am thoroughly convinced that no one on earth can tell youwhere to put your stop.
The truth is, only you can decide. Unless you are trading amechanical system or following an adviser, the responsibility isyours. If you are calling your own trades, there is no way you canpass that responsibility to anyone else.
  
Since proper stop placement is such an importantresponsibility, let's take a few minutes to reflect on some of theitems that must be taken into consideration when placing stops. Wewill return to these individually later on and view them in the contextof whether we are using the stop to protect against loss, protectprofits, or seek an objective.
Specific ConsiderationsThe size of the margin account. Certainly, the size of your
margin account will affect where you are able to place stops. It willeven affect the selection of markets in which you are able to trade.
120
 
2. Margin requirements. The margin requirements set out bythe exchanges, and any additional requirements set by your broker,will affect which markets you can trade, as well as where you placeyour stop.
3. Your individual psychological and emotional tolerance forpain, that is, your individual comfort level, greatly affects stopplacement. Provided you can afford to trade in the market you havechosen, this is probably the most important factor in setting stops.You might have a $100,000 account, but if taking a $200 hit willdevastate you psychologically, then you cannot set your stop thatfar away.
4. Your economic tolerance for loss. Your willingness to losea certain amount of money and being able to afford it even though itmakes no sense. If you are stopped out with a loss often enough,you will reach the point where you will no longer have money tolose. Therefore, you must have a rational approach to stopplacement.
5. The number of existing open positions already held. If youare already positioned in other trades, you may not be able to setyour stop properly in any new trades. In that case you may beforced to miss a good opportunity, or to set stops too close.
6. Market volatility. This is a market generated criteria forsetting stops. The market may be too volatile, causing you to needto set a stop beyond your affordability or comfort level. Conversely,using a market-generated criteria, volatility may be not sufficient toeven warrant entering a market let alone placing an effective stop.The stop would be too close to the price action and virtually certainto be hit.
 
7. The rate of trading. Whether you are in a fast or slowmarket affects stop placement. If a market is moving quite fast, youmay have to set a stop further away than is affordable orcomfortable.
121
 8. Tick size. Usually, when a market is fast, or highlyvolatile, the tick size will also increase. That means your usual andnormal stop will not suffice. An example would be if you limitedyour losses to $250 on a five minute S&P chart, and suddenly theticks moved away from the normal five to ten points per tick totwenty-five points per tick. In other words, the market becomesfast. It would only take two of these super sized ticks movingagainst you to take you out of the market.
9. Participants on the floor. When a large commercial, orlarge trader steps onto the floor, the market may begin to do strangethings. These operators often have the resources to move themarket. They may move it up quickly so they can go short from ahigher price. They may sell it down quickly so they can go longfrom a lower price. Whatever their reasons, knowing who is downon the floor can affect where you place your stop, or even whether
you should enter a trade.
10. Liquidity. Whether a market is thin or liquid affectssuccessful stop placement. Thin markets tend to be much morevolatile than liquid markets. The operators in thin markets can "run"the markets more easily than operators in liquid markets. Thisvolatility can greatly affect where you have to place a stop. Inaddition, operators can more easily run stops in thin markets.
11. Turnaround time.
a. Your reaction time, in part, dictates stop placement.How long does it take you to see and react to a situation? If you are
slow, plan on using larger stops.
b. Your brokers reaction time, in part, also dictates stopplacement. If your broker is slow in getting your orders to the floor,you will need to use larger stops. You might consider placing stopsahead of time if slowness is a problem.
c. Your relationship with your broker. If you and yourbroker like to chat and exchange pleasantries, you will need to setyour stops further away. Time is money. Markets can movequickly. The longer the time you spend in taking care of business,the more you will have to risk in stop placement.
122
 
12. The time frame of the chart in which you are taking tradingsignals affects stop placement. Obviously, you can use smallerstops in lesser time frames than you can on the greater time frames.If you are trading from weekly charts, you can be a lot more casualand leisurely about setting your stops. You will also have to be ableto afford larger stops, because markets move a greater overalldistance on a weekly basis than they do on a five minute basis.
13. Your overall objectives and strategy for the trade. Forinstance, if you expect to make a long term trade, you would placeyour stop a lot further back than if you were anticipating a short
term trade.
In view of the preceding points, how can a trader expectsomeone else to tell him where to place a protective stop? You, andonly you, are in a position to know all of these things. And whilesomeone else may know some of these things, only you can knowyour comfort level.
Also, in view of the considerations I've presented, isn't it a bitludicrous to set loss protection stops at a fixed number of points, aset money amount, a previously determined percentage away fromthe price action, or based upon the dictates of a mechanical trading
system?
None of these methods has anything to do with the reality ofprice action in the market, or the trader's economic, mental, oremotional condition, or any of the other conditions mentioned.
Stop placement is truly the arena in which you separate themen from the boys.
123Mechanical Systems
No discussion that concerns separating the men from the boyswould be complete without mentioning mechanical trading systems.Therefore, before going on with my discussion of stop placement forloss protection, let's digress a bit in order to peer into the concept ofmechanical systems. It seems as if many feel this is the solution tostop placement.
| realize some will have read the following material in other ofmy writings. | feel the concept | present here is very important,so if you have read it previously, please read it again.
 
It is said that imitation is the highest form of compliment.Some of the people who have come to my seminars have paid methat highest form of compliment — they want to learn to think as |do. While | feel unworthy of such high praise, there is no doubtmore to this concept than | ever imagined. I'm sure, to a certaindegree, trading is in the mind and thought processes of the trader.At a recent seminar | shared a thought with those attending. It's athought | don't mind repeating and sharing with others. It has to dowith computers and mechanical systems. More importantly, it hasto do with discipline.
Over the years | have seen numerous intellectual individualswho have tried to automate trading. They have tried to turn tradinginto mechanized systems. | have never personally met anyone whosucceeded at this, but | feel that my statement needs to be qualified.
| have known professional traders trading managed money whowere able to use models in their trading. Notice the plurality of theword models.
 
These traders ran several models. They had models for tradingin congestion, and they had models for trading in a trend. Thesemodels ran simultaneously in the markets desired for trading. Themodel producing the best result in a trending market is traded in atrending market. The model producing the best result in congestionis traded in congestion. All other models are constantly fine tunedso that they can be adjusted to current market conditions.
124
 
 
By continuously fine tuning, optimizing, and adjusting, there isalways a model from which to choose. One model is alwaysoutperforming the others.
This type of automated trading is very expensive and timeconsuming. It is far beyond the reach in both time and money of theaverage futures trader. The amazing thing is that it rarely doesbetter than a good individual trader who knows a market and tradeswell in that market.
| know one trader who has been trading professionally for moreyears than I. He is a very large trader, one of the "big hitters." Formany years he has paid a programmer holding a Ph.D. in physics andmath, to program every method and system imaginable. Thisprogrammer is currently paid in excess of $150,000 a year.
In addition to systems conceived in-house, many purchasedsystems have also been employed. The conclusion of the matterhas been that no mechanical system attempted has been able tooutperform the professional trader himself. No stone has been leftunturned — no expense spared in trying to find an easier or betterway than what can be done by the human factor. The money spenthas been in vain, other than to prove, at least to my friend, that itcannot be done.
An expert in artificial intelligence has been called in, in anattempt to computer emulate the trading of my friend. There aresimply too many details, nuances, and variations. What can be seenby the human eye and interpreted by the human brain is beyond theability of any programmer to translate into a computer program.
On the surface of it, it would seem that the Ross hook is ahighly programmable phenomena. Yet, those who have tried haveall had to admit failure. The hook can be computer emulated to apoint, but not completely.
The Need for AutomationIs there a need for automation? Yes, there is. But in an area
you might not immediately consider. What you must do to becomea successful trader is to automate yourself.
125 
Yes, learn to automate your behavior in the market. Diyourself to act and react in certain ways to various market
conditions.
 
When you see a trending market pause to correct, leavingbehind a hook, and when your filters all indicate a market entry, then
condition yourself to take that opportunity.
Do not waiver. Do not hem and haw. Your actions must beautomatic, but based upon an intelligent deployment of theknowledge within your possession. .
In this regard, trading is like the martial arts. You must be sowell trained and conditioned that you act automatically andappropriately to market stimuli.
If the trade is not going your way, exit immediately. Nowavering. No wondering. You go out. You do it now!
If a developing opportunity gives you any pause for thought,refuse that trade. It must be your trade. It must happen your way,when you are ready for it. There can be no "but's", no "maybe's.”If it does not have your name on it, leave it alone.
If you have placed a limit order in the market and it is not filled,and the market goes on to make what would have been a wonderfultrade for you, there can be no regrets. You cannot afford to stopand mourn over trades missed. You must be looking to the nexttrade, to the next opportunity. Above all, you must not changewhat you are doing simply to accommodate the missed trade. Thatkind of thinking can be disastrous. Drill yourself to stay with whatyou know works for you.
You cannot automate the market anymore than you can controlthe market. Just as your actions and reactions are the only thing inthe market which you can control, so it is with automation. You canonly automate yourself.
Stop and think about it. To successfully trade a mechanicalsystem, you must develop the discipline to follow it religiously. Thatmeans blindly following the dictates of an electronic machine.
126
 
If you're going to blindly follow a system, why not blindlyfollow your own reason, based upon the best computer that hasever been available — the human brain?
Unlike what many would have you believe, trading amechanical system does not remove the emotional strain of trading.It does not get rid of the suffering so many experience. Theemotional strain remains. It is only relocated to another area. Youare forced to agonize under the terrible drawdowns associated withmechanical systems. You have to trade not knowing exactly whyyou are doing what you are doing. You have made a mechanismyour god. You must bow to its dictates. If you are trading a systemthat uses daily charts, there are still the same sleepless nights whenyou get in trouble. If you are daytrading, there is still the same gutwrenching agony of seeing the trade go against you.
You still have to grit your teeth and hang on. You dare not getout, even in the face of disaster. The moment you take anyinitiative and act apart from the system, you have broken thesystem,
Is there any virtue in sitting still while your mechanical systemdestroys you financially? | doubt it. The very same discipline thatyou must exercise to withstand the withering heat of mechanicaltrading could be harnessed to work for you if you are determined to
make it so.
We all have a computer. It's our own brain. No mechanicalmonstrosity has ever come close to the marvel you carry around in
your own head.
Your job is to learn to act upon what your human computer istelling you. Isn't it easier to develop that kind of discipline than toforce yourself to become the slave of a machine?
Is there any better computer than the one housed betweenyour ears? No!
It is not one bit harder to follow the dictates of human reasonthan it is to follow a mechanical trading system. Both require adiscipline and faith that is tantamount to religion.
127Seldom, if ever, can an electronic computer relate the myriadof variables needed to make a trading decision any better or fasterthan your brain. The computer simply cannot see all therelationships in any manner approaching the adeptness with which
you can see it with your own eyes.
Most traders confuse their inability to control their emotions,their human behavior, with their ability to know what is going on inthe markets.
You know what to do. You simply do not act appropriately towhat you see.
The computer is not going to see any better than you do.Therefore, if you can determine to follow a mechanical system, youcan equally determine to follow a system based upon your ownhuman logic and reason. After all, a mechanical system is not goingto be any better than your own or someone else's logic and reasontransferred into the computer via a programming language.
Learn how to trade. Learn to read what a market is showingyou, and then discipline yourself to follow the dictates of the bestsystem you can have for you, the one based upon your ownobservations and knowledge.
128
 
| look at it this way:Here are two computers:
 
Each gives buy and sell signals. One is a personal computerprogrammed to follow certain linear relationships in the market. Theother is the human brain, trained and educated to see complexrelationships in the market. PC can view the market only serially. Itcannot multiplex ideas. No matter how carefully it is programmed, itcannot possibly reason or take into account the myriad combinationsthat occur in the market.
 HB can view the market in a multiplexed fashion. It seesnumerous relationships within moments. It is able to comprehendthe big picture in context, relative to everything else that is going onin the market. While it may not register every combination ofevents, it is able to take into account multiple combinations that dooccur in the market. It can spot formations even though they do notexactly conform to a specific definition of what those formations are
supposed to be.
For instance, HB can spot an intermediate high or low in themarket, and judge it to be that in relation to all other highs and lowsin the market. It can see /\\ and \/V/ formations in every imaginableway they can occur, along with heads and shoulders, pennants,flags, megaphones, etc. In fact, it is the ability of HB to makejudgments that sets it so far above PC that the gulf between them isimmeasurable.
As mentioned previously, both these computers give buy andsell signals.
Is it any more difficult to develop a discipline surrounding thesignals from HB than it is to develop a discipline surrounding thesignals from PC? | think not! It takes no more discipline,determination, and mind set to state, "I will follow the signals fromHB," than it does to state, "I will follow the signals from PC." Infact, it is harder to blindly follow the signals from PC — it takesmore discipline.
 
Is there any virtue in attaining to the greater discipline requiredto follow PC? No! But because it may appear that way, manychoose it, thinking that somehow the market is going to rewardthem for doing so.
It is the decision to blindly follow signals that makes a systemmechanical. The act of blindly following invokes the faith anddiscipline involved in successful trading. Once you have a methodor system that gives more dollars won than dollars lost, all that isnecessary is to develop the mind set, diligence, and determination tofollow that method or system.
130
Notice, | said a method or system that gives more dollars wonthan dollars lost. It does not have to give more winning trades thanlosing trades. It's the end result that counts. The plus dollars haveto exceed the minus dollars.
Once you have a vehicle that gives that kind of result, it does
not matter which computer gives you the signals. However,because of the ability to make judgments, personally I'll take thesignals from HB any time over those from PC.
 
As previously stated, stop placement is where you separate theknowledgeable mature trader from the amateur trader who sti doesnot know how, when, or where to place stops in the market. Stopplacement is where you separate the "men" from the "boys
 
Placing a Loss Protection Stop
Of the many stop-loss placement techniques | have seen, onlytwo have proven continuously successful over the years. Only twohave made any sense at all. One method uses natural support andresistance for placing stops. The other uses market volatility todictate stop placement. In both cases, we allow the market to tellus where to put the stop. We then filter that knowledge through ourfinancial, mental, and emotional condition.
If the market is telling us where to place a stop and that stop istoo far away for comfort, then we do not take the trade. Or, if
placing the stop where the market indicates would create too great afinancial risk, we refrain from taking the trade.
Using Natural Support and Resistance
I'll now show you what | mean by “natural” support andresistance. Let's look at a nicely trending market in Crude Oil.
131CL G DAILY
Natural support points
   
Herter tbe PELE EE need
SEP ocT Noy DEC
Natural support and resistance points are those places in atrend where prices either move sideways for a brief period or whereprices make some sort of correction by moving counter-trend for afew bars.
These stops usually work because price action in the markethas previously held at those levels. If recent price was too high ortoo low at that level, then price will probably be considered too highor too low at that level in the near future. These stops takeadvantage of the natural support and resistance in the market.
132
 
If prices at a natural point of resistance or support do not hold, Tnthen the probabilities are that we have been wrong in our estimationof market action, and we are better off being stopped out of thetrade. |
| have a tendency to use natural support and resistance pointswhen planning a longer term trade for the time frame in which I'mtrading. The next chart will illustrate this concept. The main thingis to set the stop in light of my objectives and strategy.
SH DAILY fOn the chart below, ve see major basing action by March Soybeans. 61
If I were anticipating a long tern trade, I would want to place ny 615| stop below a natural support point as opposed to perhaps a stop 61based upon market volatility. If I vere anticipating a short tern 68trade, I would use narket volatility as opposed to a natural support 686!point. My stop placement should reflect my trading objectives and 6838| strategy. 608597}| si| 5918S88}585}582!
iy il =
S61II | f 3 mee support. oem
  
sttectteleteeatiil
oct
 
DEC JAN
133 | 
 
Advantages and Disadvantages of Natural Stops Anticipating a bull move in Corn, technically supported by thestrong basing action on the chart, | would want to use a natural
The single greatest disadvantage to using natural stops is at support point. However, if | took the most natural support point, |one and the same time its greatest advantage: Prices may be too far would have a stop substantially away from current prices. I'veremoved from the current price action. shown the alternative stop placement point | would have used.Natural stops are easy to see on a chart once prices move CH DAILYaway from them, and in a trending market prove to be remarkably 2688safe. They tend to keep you in a trade for a long time. 2678. 2668A big disadvantage to using natural stops is that at times