Swing Trading (HPSS)

HPSS, or “High Probability Swing System,” is our ground-breaking swing trading advisory that delivers precision targeted long and short ideas, every trading day, an hour before the market opens.

We are working on a comprehensive special report (40 to 50+ pages or more) that describes the HPSS swing trading methodology in extensive detail. We are also working on a “How to Use HPSS” video tutorial.

In the meantime, please explore the FAQ below to find out more about how HPSS works.

The HPSS FAQ is an evolving document, which means new Q&A will be added regularly.

If you have a question you would like answered, please submit it to: hpss@mercenarytrader.com

Click “GO” to scroll down for answers (more coming!)

  • How much capital should I risk per trade — and how much do I need to start swing trading? [GO]
  • I noticed that the risk/reward for most of your trades is smaller than 2x. Can you explain? [GO]
  • How do you expect HPSS to perform over various market cycles — and how will average win percentage be impacted? [GO]
  • I love the HPSS trading signals, but I want more. I want the full trading mentorship experience. I want to know answers to questions like: How do you size your positions? How do you ride longer term trends? How do you manage a total portfolio… balance long and short exposure… think about markets from day to day… and so on. [GO]
  • Why do you enter HPSS trades with buy stop limits (long) and sell stop limits (short), instead of just using limit orders or going in at the market? [GO]
  • A quick refresher on stop limit orders [GO]

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How much capital should I risk per trade — and how much do I need to start swing trading?

We generally recommend a planned risk of 50 basis points per trade, or 1/2 of 1% of capital per trade (0.50%).

So, for example, with a $100,000 trading account, a planned risk of 50 basis points or 1/2 of 1% per trade would be $500:

  • $100,000 x 1% = $1,000 x 1/2 = $500

With a $10,000 trading account, a planned risk of 0.50% would be $50 per trade:

  • $10,000 x 1% = $100 x 1/2 = $50

You can also make a more direct calculation by multiplying total risk capital by 0.0050 to get the 50 basis points planned risk amount (0.0050 = 1/2 of 1%).

“Planned risk” does NOT mean the entire amount of capital allocated to the position, but rather the amount intended to be risked if the trade hits your risk point.

So, for example, if you wanted to go long a stock with $500 planned risk (0.5% of a $100K account) and $2 of initial risk (distance from entry point to risk point), you would buy 250 shares:

  • 250 shares x $2 risk per share = $500 planned risk

Notice that, if the stock in the above example is trading at $50, you would actually be purchasing $12,500 worth of stock, which would tie up $6,250 worth of capital in a standard Reg-T margin account. But again, your planned risk in the example is $500, because that is the distance between entry point and risk point ($2) x 250 shares.

50 basis points of planned risk per trade sounds like a small amount, but it is actually reasonably aggressive. Based on this standardized amount and HPSS trading stats as of this writing, 50 bips per trade produces an annualized account return of 57.69% 57.90% (rounding excel sheet adjustments):

HPSS stats as of: 05/17/12
Win / Loss Ratio: 46.67%
Average holding time (days): 4.56
Average R multiple per trade*: 0.19
Average profit per trade**: 0.10%
Trades per week (closed): 10.18
Average profit per week: 0.97%
Average profit per month: 3.88%
Average profit per year***: 57.90%

*R multiple = avg gain (loss) as % of avg initial risk per trade.
**Avg profit % based on 1/2 of 1% planned risk per trade (50 bips).
Higher planned risk = potential higher returns AND higher volatility!
***Avg profit per year = monthly compounded [(monthly)^12 mo].
All signals verified via live broadcast prior to market open.
Hypothetical calculations do not include commissions.
NOT AN INVITATION TO BUY OR SELL SECURITIES.
Please see legal disclaimer for full details.

Can you risk more than 50 basis points (1/2 of 1%) of total account value per trade, and thus increase your annualized return?

Certainly — it is your decision, dependent on how much leverage you are willing to use and how much “heat” you are willing to take (more on that below)…

In terms of how big an account size you need to trade, there are multiple angles to this question. How much capital you need to trade depends on at least three things: goals, risk tolerance, and experience.

  • GOALS: What is your intention? Are you hoping to make a living wage from your trading? Are you trying to supplement an outside income with some extra vacation money, or beef up a retirement fund? Or are you working with ‘tuition capital’, where your primary goal is not monetary — for the moment anyway — but instead to gain experience and confidence in your trading capability and methodology before committing real funds?
  • RISK TOLERANCE: how much ‘heat’ are you willing to take on your available risk capital? Let’s imagine two traders, Joe and Moe. Joe only has $5,000 to trade with, and if he lost half of it he would consider it a disaster. Moe, on the other hand, has $50,000 in his trading account – but he considers it “messing around money.” In this example, Moe can take a lot more ‘heat’ (account volatility) than Joe. The difference is a matter of preference.
  • EXPERIENCE: More on this in a minute…

The amount of heat you are willing to take is a big factor in how aggressive you can be, relative to your capital at risk.

If your goal is to generate a 300 percent annual return, for example, you have to accept the possibility of a 60 or 70 percent drawdown. If you are aiming for a 30 percent return, your bet size can be much much smaller, and thus your downside volatility too.

As a side note, there is nothing wrong with taking the risk of a 60, 70, or even 90 percent drawdown — if you CHOOSE to take that level of risk and are COMFORTABLE with that level of risk — as long as the capital in question is deemed “high risk capital.” Moe, from our early example, might have $5 million in his IRA account – the 50k could be an easily expendable sum to him.

The point here is NOT that you have to be rich to be comfortable — it is that portfolio heat is a function of trading size, which is a choice.

Let’s go back to Joe, who only has $5,000 and isn’t comfortable risking even half of it. Can Joe still trade? Yes, if he trades very small.

One nice thing about stocks is that you can make your bets as granular as you like. Joe can trade as few as 5 or 10 shares at a time if he likes; risking less than $2 per share on average, that would keep his portfolio ‘heat’ very low.

Of course, you aren’t going to get rich trading tiny lots with $5,000… in order to turn $5,000 into, say, $500,000 — which is absolutely achievable, we know traders who have done it, more than once — you have to be willing to run that $5k account down to fumes a couple times, then top it up again for another shot.

So if Joe isn’t going to get rich trading tiny lots (10 or 20 shares each etc), then why is he involved?

This goes back to the last factor — experience. If you are trading with the explicit goal of GAINING EXPERIENCE, then starting super small is perfectly okay.

Back to Joe and his 5k; maybe he wants to see if he can make 30 or 40  percent on his small account as a test, and to see if he can handle a small amount emotionally, before saving up to put more capital to work.

The great trend trader Richard Dennis — who once ran $400 up to $200 million, how’s that for small stake / big result! — has said (paraphrase), “When you are starting out, you want to be about the worst you can be.”

What that means is, as a new trader finding your way in markets, you will be prone to certain mistakes, as you find out more about trading and yourself. And so it is perfectly acceptable, wise even, to trade very small as you gain confidence and experience.

Now, going back to the original question – how much is needed to swing trade HPSS signals (or just swing trade in general)?

There is no amount that is right or wrong; it depends on your goals, risk tolerance, and experience. Trading small, even super small,  is perfectly acceptable with experience gains and “market tuition” the main purpose; trading highly aggressively is also fine, as long as you can “take the heat” (with such understanding that the larger your position sizing as a function of planned risk per trade, the bigger the moves in both directions).

As a side note, if you hope to make a living from trading, you want to be conservative in your percentage return expectations, and have a very solid cushion of capital. But the details on that are a separate question, worthy of its own detailed answer…

Questions / comments: hpss@mercenarytrader.com

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I noticed that the risk / reward for most of your trades is smaller than 2x. Can you explain?

This is a great question that deserves full explanation. Here is an opening attempt…

In the late ‘90s I had a commodity broker boss who liked to say, “Conventional wisdom is not necessarily wisdom that will enrich you.” While we fully agree that taking too-small profits is a mortal sin, so too is being greedy (letting profits consistently slip away), and / or not developing an R protocol appropriate to the trading strategy.

For those unfamiliar, there is a term known as “R” which represents the reward to risk multiple on a trade. You get this by taking the profit amount (or profit expectation amount) and dividing it by the max planned risk amount.

For example:

  • If a trade makes $5.00 with max planned risk of $2.50, that trade would have an R of 2 (because 5.00 / 2.50 = 2).
  • If a trade makes $3.00 with max planned risk of $2.00, it would have an R of 1.5 (because 3.00 / 2.00 = 1.5).

R is a useful statistic and a helpful guideline in evaluating trade performance. As a general rule of thumb, a tension exists between high “R” and low “R” trades:

  • High R trades have a larger payoff relative to risk – attractive for obvious reasons – but occur less frequently. (As with many other natural phenomena, directional trend excursions tend to follow a power law.)
  • Low R trades have a higher probability of success, with a trade-off of smaller gains when you win.
  • So which are better, High R or Low R trading strategies? There is no set answer for this: It depends on a number of customized situational factors such as trade frequency, commission and slippage costs, leverage requirements, equity curve volatility, strategy capacity, personal trading preferences, and so on.

The swing target HPSS uses is set at in R range roughly between 1.4 and 1.9 (adjusted after a period of testing and research). This means the profit expectation amount is between 1.4x and 1.9x the planned risk.

This range was chosen deliberately, for reasons having to do with Average Trading Range (ATR), average initial risk parameters, and other factors that will be explained in full detail in an upcoming HPSS special report. (A FAQ on Average Trading Range [ATR] and its impact on risk point parameters will come shortly.)

Is a 1.4 – 1.9R standard target “small?” That depends on how you look at it, based on factors like time frame, trade frequency, winning probability, and so on. Keep in mind too, though, that ‘R’ is not the same as ‘effective R.’

What does that mean? Well, effective R is trickier to calculate, but here is how to think about it:

  • If you are constantly tightening risk points on your trades (through good trade management), then your average trading loss over time will be smaller than initial risk in relation to your average target gain — thus increasing your effective R.

An example:

  • Let us hypothetically say that, on average, your tend to net $3.00 in profit per equity swing trade, at an average risk of $2.00 per share on your initial stop. That is an average R of 1.5 (because, again, 3.00 / 2.00 = 1.5).
  • But now let us further hypothetically say that, because you routinely ratchet in your stops — moving the risk point closer as price action allows — your actual average loss (over a wide number of trades) is smaller than the initial $2.00 risk, and is closer to $1.00.
  • In this case, your effective R would rise to 3 — because, while you are setting your initial risk point at $2.00, most of the time you manage to bring it in quickly… so your effective R on booked trades, over a statistically significant number of trades, is [3.00 avg win / 1.00 avg tightened loss] instead of [3.00 avg win / 2.00 avg initial risk].

(So why start with a wider risk point at all if you are just going to be moving it in quickly? That’s another good question, worthy of a separate answer.)

Basically, though, you won’t get a true sense of your “effective R” until you have made a statistically significant number of trades. The other reality is that, while your average risk will come in tighter, your average booked profit can move too, as profitable exits will vary – not be confined to the original swing target — based on trade management habits and market conditions).

Bottom line: 1.4 ~ 1.9R is a deliberately chosen starting point, not reflective of ‘effective’ R or ‘true’ R, because we rein in our risk aggressively on open positions as market conditions allow.

But why not go for a larger target R? Why not try for 3R, or 4R, or more? Because of the “power law” consideration – the farther away your target, the less often it will be successfully hit before the market reverses course.

There is an optimal balance here between trade profitability and win probability — setting your target in light of the twin considerations of 1) likelihood of being hit, and 2) maximizing potential gain.

To better explain the above, Average Trading Range (ATR) must come to the fore once again (worthy of treatment in a separate answer)…

Questions / comments: hpss@mercenarytrader.com

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How do you expect HPSS to perform over various market cycles – and how will average win rate be impacted?

As a versatile and powerful swing trading service, we expect HPSS to hold its own in all market cycles. But, obviously, some cycles will produce more gains than others. Time will tell, but we expect the long-term average win rate for HPSS to settle around +55%.

This 55% average hit rate – again an informed estimate, not a target or guarantee – will be the long-term result of a wider fluctuation band, spread over various cycles, that likely ranges from a high of +80% to a low of around 40%.

We also expect the average ‘R’ capture per trade to fluctuate in a range. While remaining steadily positive (i.e. net profitable) over the duration, thanks to consistently larger gains than losses, realized R will be larger in the most favorable cycles, and smaller / tighter in more challenging cycles. (Note: Another F.A.Q. explaining “R” will be posted shortly.)

In plain English, the above means we expect a meaningful spread between the best and toughest market climates:

  • In the best market climates we will see win after win after win, with amazing streaks that seemingly go on forever, and maximally favorable R to boot (hitting the full profit target over and over again). We will have the “hot hand” in these conditions, like a pool player running racks. But…
  • In the toughest market climates, we expect to see a lot of chop and “head fakes” in terms of broad market directional change. This will lead to earlier exits on tightly reined in risk points, a higher number of breakeven or small loss positions, and overall much more of a “grinder” result (while still – knock on wood —  squeezing out reliably positive returns).

What accounts for the difference between optimal market climates and tough market climates? One key thing – the consistency of institutional capital flows.

By institutional capital flows, we simply mean what “the big money” is buying or selling. These are the huge mutual funds and pension funds; the guys who run tens of billions or even hundreds of billions, and who routinely take days / weeks to move in or out of a position.

Trading “bots” create a lot of noise in the market with their constant activity, but their tiny holding periods (often less than one second) and constant rapid-fire reverses mean the bots have little influence on trends. The hyperactive nois tends to cancel itself out.

In contrast, the gigantic institutional players, aka the “elephants,” create the bulk of directional movement in the market with client-driven market activity that persists over days, weeks, and months. When public money comes in the door – think Uncle Ted buying a new mutual fund, or Aunt Gladys contributing to her 401k – the institutional managers handling the flows have to put that cash to work in their chosen names.

Then, when redemption requests come in – Uncle Ted decides to cut back on stocks, Aunt Gladys switches to buying gold coins – these same managers have to turn around and sell if net cash levels are low. Dribs and drabs, every day, either net buying or net selling.

And the elephants don’t just buy, to paraphrase trend trader John Henry: They “buy, buy, buy, buy, buy.” Conversely, nor do the elephants just sell – they “sell, sell, sell, sell, sell.” These forces are as relentless as the tides. They will never stop, unless the market stops… and they create huge opportunity for swing traders like us.

  • In medium to strong trending bull markets, institutional money managers will consistently be pumping more and more money into the market, buying their favored names on a clockwork basis. The natural ebbs and flows in these uptrends will allow us to pick our timed inflection point – like a surfer dropping into a wave  – and then ride that wave back to shore, over and over again.
  • On the flip side, in medium to strong trending BEAR markets, institutional money managers will consistently be pulling money OUT of stocks. As explained above, day after day they will be facing client redemptions. In broad market downtrends, the elephants will see orders to “sell” $50 million worth of holdings every day, rather than buy as with bull market periods. And when those redemptions come in, they HAVE to sell – there is simply no choice.
  • This is why true bear trends can just keep grinding down and down, until the long-only crowd throws up its hands in disgust. These conditions too can be great for us – in full-fledged bear markets, we simply go short much more often than long. The market surfer switches stance, and we ride the bear waves into shore, over and over yet again.

So where does the “grind” of tough market climate come in?

It’s the in-between periods, i.e. low- or no-trending markets, where there is much more confusion than clarity as to where the flows are going. When uncertainty reins, there are no dominant undercurrents of institutional buying or selling one way or the other, but instead multiple small eddies and currents that cancel out and contradict each other.

(To stick with the surfer analogy, imagine rough, choppy waters with intermittent sunshine and storm clouds, where promising waves peter out much faster and routinely shift direction in high winds.)

Why is it important for you to understand this market condition variance? Mainly so you can know what to expect, and thus remain a “cool customer” at all times:

  • In optimal market periods, it’s important not to get sloppy or greedy as a result of racking up wins day after day. When you are seemingly winning every hand, the temptation is to cut corners on risk management: To start taking dangerously large positions, ignoring risk points, thinking about that deep sea fishing boat you’re going to dock down in the Caribbean instead of focusing on the market that day, etcetera. You want to maintain your “A game” in these heady times by remembering that, as with the seasons and ocean surf conditions, market conditions change too.
  • Conversely, when markets are in “slop and chop” mode, it’s important not to get frustrated or impatient when booking profits feels like squeezing blood from a stone. As with the most optimal market climates, the thing to remember with tough market climates is “this too shall pass” – and furthermore that tough market climates present great opportunity to truly hone and sharpen one’s trading skill set. (As the old saying goes, “A smooth sea never made a skilled mariner.”) If you can “grind it out” in tough conditions – rather than giving back large chunks of capital, as most traders do – you have a shot at truly fantastic long-term returns.

Questions / comments: hpss@mercenarytrader.com

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Q. I love the HPSS trading signals, but I want more. I want the full trading mentorship experience.

I want to know answers to questions like: How do you size your positions? How do you ride longer term trends? How do you manage a total portfolio… balance long and short exposure… think about markets from day to day… and so on.

A. HPSS is meant to be a highly flexible trader’s resource.

You can use the HPSS signals any way you like. For example, you can take the entries and swing targets exactly as presented. You can ride the positions for larger trends, while using partial trailing stops. You can use options instead of the underlying (as long as you watch the liquidity). You can use our entry points to build investment positions, or use our short ideas to balance out a long portfolio. And so on.

At this point, you may be wondering — what exactly do WE do with these signals? How do we, Jack and Mike, make use of the HPSS output?

After all, we are active money managers who eat our own cooking. (Rules restrict us from saying too much about money management stuff; please see our disclaimer for details.)

So how do we (as in Jack and Mike “we”) use HPSS signals?

The honest answer is, “it depends:”

  • Sometimes we take the swing signals exactly as presented (to the sound of a cash register ring).
  • Sometimes we set an alert at the ‘swing target’ and hold for larger trends, managing off the alert when hit.
  • Sometimes we call an “audible” and exit a position in the last hour of the trading day.
  • Sometimes we use a “scissor stop,” to tighten up on half the position and let the other breathe…

And we significantly vary our position sizes over time, depending on factors like the current state of the market, the overall positioning of the portfolio, and so on.

So how does one get access to all of the above — to the nuanced, real-time judgment component of what we do?

By upgrading to our flagship service, the Mercenary Live Feed.

But what about HPSS, you ask?

This is where the “free” part comes in:

When you subscribe to the Live Feed, you get HPSS too — at no extra cost.

Here’s the deal:

  • The Live Feed is Mercenary Trader’s ‘flagship’ service. It shows all our trades, made with real money, in real time. It gives full visibility into our trading decisions, market commentary, levels of aggression vs conservatism, advanced strategies – everything.
  • HPSS and the Live Feed have a child / parent relationship. With HPSS you receive our real money signals in easily digestible swing trading format, but not the trade management, live mentoring, real time aspects of the Feed itself. (We also do occasional ‘advanced’ trades, with currencies and option structures etc, that will not show up in HPSS.)
  • Because the trading signals for these services often overlap — and because the Live Feed is the “full monte” — Live Feed members automatically receive HPSS access (if they request it) at no additional cost.

By now you’ve likely figured out something else: The Live Feed costs more.

Indeed it does, and rightly so: At $995 for a full year’s subscription, the Live Feed is roughlytwice as expensive as HPSS’ debut annual price. (That multiple may rise, but we are keeping it reined in for now.)

With all we deliver, we believe the Live Feed is an INSANELY good deal at just $995 per year, let alone the soon-to-disappear $795 price (which will be here til the end of this month).

Many LF members tell us the Feed is like nothing they have seen or experienced anywhere. That is partially why the price is going UP — from the old $795 annual to a new $995 annual — permanently and forever as of June 1st.

But for now,you can still get the $795 annual (and lock it in for 2 years)

The point of all this is as follows:

If you want the full mentorship experience –the whole enchilada, the works, the next best thing to sitting on the trading desk with us – then subscribe to the Live Feed, and you will get BOTH the Live Feed andHPSS for one rock solid price.

Q. What if I want to start with the lower cost HPSS, and upgrade to the Live Feed later?

A. That’s no problem — you can upgrade at any time. Whenever someone with an HPSS subscription upgrades to the Feed, the value of their HPSS sub is credited on a pro rata basis. You can do it early or you can do it later; and when you choose to try the Feed for the first time, you can even take a 14 day trial to make sure it’s right for you.

A few other quick points:

  • If you are already a Live Feed member, you can email us via livefeed@ and say “I would like to be on the HPSS broadcast list,” and it’s done.
  • If you are happy to follow HPSS exactly as it stands, placing your bracket orders in the morning — a perfectly fine thing to do — then you can just sign up when the beta period ends (June 1st) and not sweat any extra details.
  • If you like the sound of the Live Feed, though, consider giving it a try before the current price goes up.
  • Again, for the Live Feed we will beraising the annual subscription costfrom $775 to $995 as of June 1st 2012.
  • Anyone who purchases at the $795 annual rate, between now and June 1st, will see that low rate “locked in” for at least two years. (Even if we are charging $1,500 in Q1 2014, you’ll be grandfathered in at $795!)

We have further lowered the risk by building in a no-obligation 14 day trial for all potential Live Feed subscribers.

On signing up, you’ll have 14 days to “test drive” the Live Feed and make sure it’s right for you.

If after 14 days, the answer is “yes,” then great — you’ll automatically have HPSS access in addition to your Feed membership, free.

Just click here or on one of the boxes above…

Questions / comments: hpss@mercenarytrader.com

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Why do you enter HPSS trades with buy stop limits (long) and sell stop limits (short), instead of just using limit orders or going in at the market?

We explained the use of stop limits versus regular stops in a separate FAQ answer. The reason we use stop limits in the first place is to establish short-term momentum confirmation.

Think of it like this: Stepping into a trade is a little bit like stepping onto a train. Before you get on a train, you want to make sure it is moving in the right direction!

Oftentimes, our requirement for that last little bit of near-term momentum — the extra push required to hit our stop-limit — winds up keeping us out of trades that go the wrong way.

On Friday, for example, our potential long setups in DHX and TKR both went tapioca. But we didn’t lose a penny on either — near-term follow through was not enough to trigger our stop-limit, and so we never got in. This will happen on a fairly regular basis, especially when a big sweeping bullish or bearish current overwhelms all stocks.

The use of stop limits for entry saves us from disappointment in many instances, by requiring that last bit of momentum — “train rolling as scheduled” — before committing to a trade.

Questions / comments: hpss@mercenarytrader.com

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Quick Refresher on Stop Limit Orders:

A “stop limit” is a specific type of order entry you should be familiar with.

With a standard buy stop or sell stop, the stop price triggers a market entry. The stop price is literally the “trigger,” and as soon as the stop is hit — or traded through — a market order is executed to buy or sell your specified number of shares at the next available trading price.

Imagine a hypothetical stock trading at $10 per share, and a normal sell stop in place at $9.90. If the share price traded down to $9.90 or anywhere below, the $9.90 stop would be “triggered” and a market order executed, regardless of where the stock is trading once the trigger is hit.

It works the same in reverse with a buy stop. With a buy stop, if the stock trades at or above your specified stop price, a market order to buy is triggered.

So, in truth, what people think of as a “stop” order is actually a “stop market” order (even though nobody calls it that). Once your stop is triggered, you get a market order fill at the next available price.

A “stop limit” order, in contrast, is one in which, if the stop price is triggered, a limit order is instantly entered instead of going to the market price.

A limit order is a shorthand way of specifying “or better.” So if you are trying to buy stock at a limit price, you want to purchase at X “or better” (lower). Conversely, if you are trying to sell stock at a limit price, you want to sell at X price or higher (when selling, higher is better).

Take the example of the $10.00 stock again. If you had a regular $9.90 sell stop in place, and the stock gapped down to $9.50 on a lower open, your stop would be triggered and your sell would be at the market, giving you $9.50 or thereabouts on your sale.

However, now let us say you had a “stop limit” order in place: Short XYZ at $9.90 sell stop / $9.80 limit. That means, when the stop is triggered, your limit order would become active to sell at $9.80 or better. If the stock gapped through your limit price, opening at $9.50 or even lower, your limit order would be entered into the market but not filled — until or unless the stock traded back to your $9.80 price “or better.”

Thus the purpose of a “stop limit” order, versus a standard stop, is to literally “limit” the outer boundary of the fill price you are willing to accept. We use stop limit orders on our trade entries instead of regular stops because, if the stock gaps away from us, the risk is too high of an unacceptably poor fill, and the limit price represents the outer boundary of what we will accept. We do not want to chase our trades.

Questions / comments: hpss@mercenarytrader.com

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Questions / comments: hpss@mercenarytrader.com

  • Return to HPSS FAQ [GO]