winners because the size of the winnings are much greater. Ratios of 2:1, 1.5:1, 1:1 will only work with a high degree of accuracy (65%-75% or better).

Before you enter any trade, always look at how the situation may affect your risk. Is the market volatile or quiet? Has the open been gapping much? Where is my stop and if it is hit how will this affect my profit and loss? Reward will need to be calculated as well. Based on my analysis, is this going to be a big or small move? Is this trade going to take days or weeks? If the market explodes in my anticipated direction on the first day of my trade, will I take the money and run or do I have an effective strategy to deal with that?

Figure 7.12 depicts the reward-to-risk ratio in action. A nice uptrend line has formed and you decide to go short when it is broken. The market falls below the uptrend line and we are now short from .6660. We decide to have a 3:1 reward-to-risk ratio. Stops are placed at .6710, a risk of 0.5 ticks. We will place our orders to get out at .6510, a profit of 1.5 ticks, thus the 3:1 ratio. When this trade is entered, we do not know the outcome ahead of time. The only thing we know is that at the end of the trade we will have either a 0.5 tick loss or a 1.5 tick profit. One profit like this equals being wrong three times.

figure 7.12 setting exit stops to produce a 3:1 reward/risk ratio.

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risk

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Close to Open

Unless you are a day trader, there is always the close-to-open risk. This was not much of a problem 5 or 10 years ago because when a market closed there was no more trading till the next days session. With the increase in international trading and the need to access the markets at all times, many new after-hours trading systems were established to meet the needs of foreign investors and global traders. Globex, Project A, and Access (to name a few) are after-hours electronic systems used to match up buyers and sellers while the markets are closed.

Because of their popularity and need, markets are now experiencing big close-to-open gaps. A gap is the difference between the previous days high and low and the new days open. Depending on the market and events that happen overnight, the gaps could be very little or none to several hundred points. Depending on the market, you may be able to protect yourself by placing a 24-hour stop that will get you out of the market when your price is hit regardless of the time. The drawback to this is that after-hours markets are often very illiquid and prices can be hit or run up/down only to fall back in line before the market opens the next day. As with anything, there are always trade-offs.

Figure 7.13 depicts how often a market can gap. If you decided to buy the market and use the low of the previous three days as support, and a break of this support as a signal to get out, then you would have experienced a nice loss as the market gapped lower on the open by almost half a point.

You may decide the market you trade really doesnt experience big gaps so keeping stops only during the day is sufficient. If you trade the currencies, since they are much more of a global market subject to news events from other countries, a round-the-clock stop may be wise.

In evaluating your results, look to see if losses occurred due to gap openings. Maybe you need to fine-tune this area of your system. Sometimes you can use disaster stops, as I call them, in the night session to prevent a market from taking all your money and then some. These stops can be wide enough to protect you from ruin without stopping you out of a profitable position because of a slight move.

Slippage

Slippage risk is that uncontrollable part of trading that we all hate and try to avoid. Nevertheless, it occurs-sometimes more than it should. Every broker will claim to have the best execution, but in reality the normal day-to-day markets will always get you your price plus or minus a few ticks. The real dilemma occurs when you have a stop in the market and the Fed raises rates creating a "fast market" where brokers are not held to the prices. Your actual fill could be much higher or lower than your stop price. Yelling and screaming to your broker probably will not make a difference, but slippage must be taken into consideration when trading. \

Are you in a position the day before an important G7 or Federal Reserve meeting? The dates of all-important economic reports are known in advance. Many times,

Figure 7.13 Market gaps. After trader places a BUY, price

gaps past the exit stop and opens much lower.

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slippage is unavoidable so definitely keep this in mind and take it into account. If your slippage seems to happen more often than you would like, check to see if the market was in a fast condition. If it was not, make your broker aware that this is a concern for you, and if it keeps up, you will need to look elsewhere.

Avoiding Limit Price Moves

Severe losses can occur when stops are not available overnight when you keep a position open, or if you do not use stops, or more important, trade in markets that have limit price moves. Limit moves do not occur all too often but in some markets they can occur once every few weeks. This is unacceptable. You always want to be involved in a market that will let you get in or out at any price.

Just imagine if you are short lumber and a surprise housing number comes out, the market moves up to the daily limit (it "limits up"), and due to the fast market your order never got filled. Seven days later, the market is still limit up, and now a $500 loss is $5,000! Trust me when I say this can happen a lot all the time.