Going Beyond The Market Noise
Noise in currency market can be defined as the day-to-day activities happening in the market. Here is an example, suppose that there is a movement of a point or two in the market price, then you are never aware whether it’s is a fishing for orders done by some traders or there was really a lot of activity in the market. And even if you suppose that there was lot of activity there, even then you have no idea whether it will remain so or not. Therefore, it is appropriate le to think that the daily activity is mostly currency market noise online. Thus, it seems better for you to place your stop outside of the range of any such noise in currency market.
Now, the important thing to know is to find out the reasonable estimate of the range of market noise online? Majority of traders like to put their stops in the neighborhood of recent support or resistance. Although, there is an issue with this particular theory. The issue is that everyone knows where those stops are. Generally, the markets are inclined to stampede in reverse and fill everyone’s stop orders before they quietly return in the direction of the trend.
As a trader, you might want to think upon placing your protective stop at a level which is not logical to the market and that is still beyond the currency exchange noise. Let us suppose that the online market noise is represented by the activity of the day - i.e., the entire day’s activity is mostly the noise. It could be represented by the average true range. In case, you are considering an average of this activity over that past 10 days, you get a good approximation of the daily noise. The next thing is to multiply the lo-day moving average of the average true range by some constant between 2.7 and 3.4 and you’ll have a stop that’s far enough away to be out of the noise in currency market. This is probably a good stop for most long-term trend followers.
There is an alternative way to look at it. This method is easy and you will get a better understanding. A wide stop is not a lot of risk if your position size is small or minimal. And if a minimal unit with that big of a risk seems like a lot of money to you, then you probably should not be trading that particular instrument--either it’s not a good opportunity or you are undercapitalized.
Also important thing to remember is that your initial stop is your worst-case risk, the maximum number of your losses will probably be about 0.5R.