The one word that describes the stock market right now is confused. A plethora of conflicting economic reports and no consistency in company earnings has left even the most experienced investor uncertain as to likely future direction.
The only certainty right now is that volatility is very likely to continue to increase as geopolitical and economic events show no signs of abating. These are the times that savvy, short term traders thrive. During steady and sure markets, there simply is not enough volatility to created profits for the short term players.
In order for longer-term swing traders to profit in the current conditions, we have developed a simple system that can profit from any sharp price move regardless of direction.
I am not talking about options or any kind of complicated derivative strategies. This system can easily be used in your stock market account with nothing other than a charting program. It can be used for individual stocks, ETF’s, or even commodities. In fact, any financial instrument can be successfully traded with this simple system.
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If you are confused about the direction of a stock or want to profit from high volatility events like earnings, this simple system is for you. A channel system that goes long or short depending on the way the stock breaks. Here’s how to do it.
The Channel System
I call this basic system The Channel System. It’s one way a trader can put a semblance of order to the recent chaos in the market. Here are the basic rules:
Use a 15-minute stock chart for setting up the parameters and trade from this chart.
There are no indicators or other technical tools used.
Observe a 15-minute chart over the last 3 trading days. Draw a horizontal line at the high of this period, and another at the low of this period.
This creates a horizontal channel on your chart. These are the parameters that you use to decide whether to go long or short
I call this channel the “no trade channel”. No trades are made if price is within the channel.
There are several variations on how this channel can be traded, but on the most basic level, it’s a breakout system. When the 15-minute bar starts to breakout above the upper line, this is a go long signal.
When 15-minute bar starts to break below the lower line, it’s a trigger to go short.
The rules dictate that once entry is made, the initial stop is if price drops back into the channel. However, once profits are achieved the exit becomes discretionary depending on your personal goals for the trade.
Some traders use trailing stops, other simply let it ride, attempting to catch the big waves.
This letting it ride will catch the big moves, but you will many times give up most or all of profits during the times the market doesn’t trend in one direction.
I don’t have a timeframe how long I stay in with this system. I like to stay in as long as possible, as the several times a year the system catches a big move makes up for the churn the rest of the time.
The 3 Must Follow Rules
- Never let a profit turn into a loss.
- 3 attempts at each entry prior to profits invalidates the channel.
- Have orders pre-set to go long on a break of the above channel line and to short on a break of the lower line.
While rule 1 and 3 are obvious, rule 2 needs a bit of explaining. What this means is if the entry is triggered but the share price doesn’t continue into profits, and you are stopped out of the trade, only give it 3 tries at that particular channel line. If the true break out does not occur within 3 tries, it is likely that there is not enough volatility at that particular level to create profits. This means to try another stock!
The Best Way to Take Profits from The System
The channel system is ideal for triggering entries into a stock. It’s beauty and simple sophistication lie in its ability to profit no matter what way the market moves.
The system will create profits for you. However, it is up to you how to manage the profits.
I have found that there are 3 primary ways to take profits from the channel system. These are the hard stop, the soft stop, and the trailing stop. Let’s look at each of these ideas.
- The hard stop A hard stop is an order to close the trade, placed immediately with your broker after or at the same time as entry.
This is the fixed increment that you are willing to lose on the trade should it not behave as expected. It can also be used to capture profits once you have them by being placed below the current price but above your entry price. For example, if you place a stock trade at $13.53 and are willing to lose 3 points prior admitting that the trade is wrong, the close order would be placed at $10.53. Should $10.53 be hit, the trade will automatically be closed protecting you from additional downside.
- The Soft Stop
Soft stops are often referred to as mental stops. They work on the same principle but they are not actually placed in the market; forcing the trader to relay on discipline and market reading skills to close an adverse performing entry.
The distance you set the hard stop depends on your tolerance for risk, market volatility, and overall trading plan.
Many traders set a one percent loss rule per trade, stops are set to produce no more than a one percent loss of the allocated trading capital for any one trade. There is much debate whether hard stops or soft mental stops are better.
It’s my firm belief that beginning traders should stick with the hard stops until their market reading skill and discipline are developed enough to permit the safe use of soft stops.
On volatile days, hard stops can result in a series of losses that could have been profitable trades using soft or mental stops. This is an area where experience and judgment play a major role.
- The Trailing Stop
The trailing stop is by far my favorite profit taking tool. I often convert a hard stop into a trailing stop once profits are realized on the trade.
A trailing stop protects your profits while allowing the trade to continue in its profitable direction. As the term states, these stops follow or “trail” price locking in greater and greater profits until price reverses and the trade is stopped out.
When I first started investing, trailing stops had to be manually moved. Today, most trading platforms trailing stops will automatically follow price at the pre-set interval. This is the best part of trailing stops, they are automatic once set on your platform. Huge gains can be made by the judicial use of trailing stops.
Once in solid profits, use the Average True Range to help determine the correct distance from price to set the trailing stop. This way the normal daily volatility of the stock will not result in the trade being closed