MINIMIZING THE RISKS

There is no way around the risks inherent in trading counter to the prevailing market action. All we can do is reduce

the risks as much as possible by using the tools available. Happily, there are ways to do this.

First, always be aware of the longer-term picture. If the market you are planning to trade is in the middle of a strong

trend, going against that action is probably one of the quickest ways to lose money. Wait until the momentum starts

to ease; this will reduce your chances of getting caught on the wrong side of a breakout.

Further, this is a good time to mention a candlestick caveat: Beware of reversal patterns signaled by candlesticks in a

trending market. The bond market is especially notorious for throwing out countertrend candlestick signals during

major trends, and I've seen the same in other markets as well. Never look at candles in a vacuum.

So what should we look at in conjunction with candlesticks to lower our risk in the countertrend trades I am

suggesting? For one, there's John Bollinger's band width indicator (BWI) as a trend indicator, which can be used by

monitoring the area between the upper and lower bands. (I outlined this technique in the November 1994 STOCKS

& COMMODITIES.) I like to use the BWI as an indicator of a weakening trend; I want to jump in when the slope of

the BWI line starts to decrease. This is the first signal that the trend is petering out, and that at this point countertrend

trades are reasonably safe.

There are, of course, other technicals that you can use. Bollinger bands themselves can be helpful, among others.

Select the tool or tools that make you most comfortable.

More important than any additional indicator you could use, however, is your money management strategy. There

are many ways you could trade using this methodology, and each has its own advantages and limitations. Cash or

futures trading exposes you to the potential for theoretically unlimited risk, requiring tight stops and quick

executions. Options could limit your risk, but probably at the cost of requiring larger moves to make them

worthwhile. Of course, you may be able to tailor a combination of instruments to suit your needs.

An important factor in determining your risk exposure, and as a result how you trade, is the point at which you cut

your losses. Often, there is no second support or resistance level nearby to provide a good stop-loss point, which

means you'll have to use your own instinct as a guide. I find it useful to use whatever candlestick shadows there are

as a rough guide to how far the market might go against me, thus letting me set reasonably good stops.

One last thing to consider: Where you're going to get out. I use a combination of techniques. Fibonacci retracement

levels work fairly well, as do moving averages. I prefer to determine another support or resistance point using real

bodies. Unfortunately, there are times when a significant level is not available nearby, forcing me to use other

techniques.