A golden rule for protecting profits

When spread betting, you need to limit your maximum loss in case the trade does not go your way. Here's how.

When placing a trade, I always use my 3% rule which limits my maximum loss of that trade in the event it does not go my way (it does happen!). The other money management rule I use is my break-even rule, which I swing into action as soon as I can.

But when to use it is a judgment call there can be no hard and fast rules here.

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Let's sayI have just taken a long bet on the EUR/USD at $1.3120. My protective stop is at $1.3075. For as long as the market trades between the two, I leave my stop where it is. If the market advances above my entry point, I start looking for a sensible point to where I can raise my stop. The problem, of course, assuming normal market volatility, is if you raise your stop to break-even too soon, there is every chance you will be stopped out prematurely before the market has had a chance to develop.

For the EUR/USD, I usually look for a move in my direction of at least 100 pips before I raise my stop.

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Ihave a great example from late December. The EUR/USD has been in a long-term bear market for two and a half years, with very wide swings along the way. But that doesn't mean I never try to find opportunities to trade from the long side, when I feel the technicals are lining up.

Here is the chart:

SB00032-01

I have drawn a valid support line which passes through the August/September and December lows.

My strategy is to go long near the line.

As the market in late December came down to challenge the line, I thought that the line would hold and give me a nice upward bounce. I formed this view knowing the bullish sentiment consensus in the euro had fallen from over 95% in October to a recent 45% reading. It indicated to me that there were now plenty of recent euro bears on board, which could provide the fuel for a counter-trend rally.

Press reports of major analysts moving over to the dollar bullish side gave me added hope! Also, the recent downward drift had occurred on a potential positive divergence. So my plan was to go long as close to the support line as possible.

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On my hourly chart, I could draw a solid downtrend line with several touch points (purple boxes). An upward break through this line could be interesting!

SB00032a-02

So, on 27 December, I entered a resting buy order just above the downtrend line at $1.3135, which was filled that morning.

My stop was just under the recent low at $130.60.

27 Dec long £2 rolling EUR/USD @ 1.3135 Stop @ 130.60 Risk 75 pips (£150 = 3% of account)

The market did rally strongly as it pushed away from my downtrend line, and the rally continued the next day as it made a high at the $1.3275 level. This was a Fibonacci 50% retrace of the down move from 14 to 23 December. When a market bounces, I always like to apply my Fibonacci tool to the previous wave as soon as I can. That gives me the likely points of resistance and/or reversal.

Since the rally was greater than my rule of thumb 100 pips, I then moved my stop to break-even.

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As it happened, the market did turn around at the Fibonacci 50% retrace, and dropped through my stop for a break-even trade.

Dec 28 sold rolling £2 EUR/USD @ 1.3135 No gain or loss

A day-trader could have taken profits near the Fibonacci 50% retrace a typical turning point. That would have given a nice 130 pip profit (or so). But you would then forego profits from any further upward move. The choice would be yours!

If you trade in this way, you should stay out of major trouble and keep your equity intact, ready for any future wins.

NB: Don't miss my next bit of trading advice. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here.

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