Define Risk Using ATR, Value and Acceleration Areas

The first task after entering a position should be to determine risk. Risk may be a physical or mental stop loss. Trading is tough enough; setting risk relieves some tension and allows the trader to concentrate on profit potential and trade management. Risk can be measured using average true ranges (ATRs) or points at which a previous trend or acute vertical move originated. Value areas may be used to increase profits while managing a profitable trade

Measure Risk with Average True Range (ATR)

Risk varies for all traders and may differ due to time frame of trade, account size, lack of conviction or fundamental reasons such as earnings or economic reports. So many factors can affect a trade. This has been especially true during the pandemic where volatility spikes often and erratic swings are frequent. This makes defining risk even more difficult. Consequently, having a methodology is imperative.

For new traders using ATR to define risk is a great way to start building strategies. The art of defining risk must include current volatility. I refer to recent average ranges or ATRs to set profit potential and risk. They allow me to be consistent with risk/reward ratios. For benchmark averages I prefer a 14-day, 9-week, 7-month and 5-quarter. A speculator or swing trader should focus on day and week ATRs. If you prefer longer-term trades, use month and quarter ATRs to set risk and profit targets. When a bullish trade is taken, I set my stop loss at 50% of an average day range below entry. My first profit target is often 100% of an average day range.

Determine Risk with Value Areas

I use 30-minute charts to define daily value areas. A day value area contains roughly 70% of the total volume. They reveal congestion zones and take the shape of a flag or rectangle. To construct a value area, count overlap in price. On the lower part of the range the bottom of value is the price that has traded in 4 or 5 30-minute periods. The same is true when defining the top of fair value where a price has traded in 4 or 5 30-minute periods. In the USO chart below, each rectangle represents a daily value. During a rally I use the value area low to define and trail a stop to lock in profits as the markets moves in my favor. When riding a short position, I use the top of value to define risk and trail my stop.

Define risk using ATRs

Acceleration Areas and Stops

When markets break into a trend, they frequently begin with candles that have long bodies and short wicks. Such candles typically have above average volume as the market accelerates either up or down. When I see a long-bodied candle I like to trail my stop loss at the open of that candle. And as the market trends I move my stop every time a new one forms. The chart below illustrates this technique.

Final Thoughts

There are many ways to manage profitable trades. Good traders find a way to lock in profits and squeeze as much out of a trend as possible. Choose one that fits your style and time frame.

John Seguin
Senior Technical Analyst
Market Taker Mentoring, Inc.

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