forex-scalping.com

How Wide Should the Buffer Beyond a Zone Be?

A resistance zone on EUR/USD spans 1.1100 to 1.1112. The daily ATR is 48 pips, and the hourly ATR is 12 pips. You plan a short entered at 1.1105 after a rejection candle.

Three candidate stops. Stop A is at the zone edge, 1.1112, risking 7 pips. Stop B adds a quarter of the hourly ATR beyond the edge: 3 pips, so 1.1115, risking 10. Stop C adds a full hourly ATR: 12 pips beyond, so 1.1124, risking 19.

Now think about what each tolerates. In a typical hour, price moves about 12 pips. Stop A leaves less room than one average hourly range, so a routine swing could take you out, even if the zone later holds. Stop C survives one full average hour of noise beyond the zone.

Check the trade-offs with a target of 1.1060, which is 45 pips from entry. Ratios: Stop A, 45 divided by 7, about 6.4. Stop B, 4.5. Stop C, 2.4.

The tightest stop produces the best-looking ratio and the lowest chance of surviving. Historical data on your own trades, using the MAE method, shows which stop has the best expectancy, but a middle buffer tied to volatility is a reasonable default.

The ratio is only meaningful if the stop is realistic. A 6-to-1 trade that is stopped out 90 percent of the time loses money.

Your turn: for your last ten losers, check whether a buffer of a quarter or half the hourly ATR would have kept you in.

Fairman, the three stop options show the trade-off between risk size and the chance of being stopped by noise. A stop beyond the zone by a fraction of the hourly ATR is a common compromise. It would be interesting to compare how often each stop would have been hit on past rejections at similar zones. Logging which of the three would have survived each time turns the choice into data.

I ran the MAE check you suggest on my last few months of zone shorts and longs, and it was eye-opening. On about forty losing trades, a buffer of a quarter of the hourly ATR beyond the zone would have kept me in roughly a third of them, and most of those went on to reach the target. Going to a full hourly ATR saved a few more, but by then the reward to risk had dropped so much that the expectancy was worse overall.

The tightest stops were the ones that flattered my numbers on paper. I used to boast to myself about trades with 5 or 6 to 1 ratios, without counting how often they never had a chance to work.

These days I place the stop at the zone edge plus a quarter of the hourly ATR, rounded to a whole pip, and I add the spread for shorts since the stop triggers on the ask. On quiet days when the hourly ATR is very small, I use a minimum of three pips so the buffer doesn't shrink to nothing.

The ratio comparison illustrates a trap many traders fall into. Stop A's ratio of 6.4 looks excellent, but with only 7 pips of room in a market that typically moves 12 pips an hour, it will be hit by routine noise very often. If it's stopped out 85 percent of the time, the expectancy is 0.15 times 45 minus 0.85 times 7, about 0.8 pips per trade, barely positive before costs. Stop C, with a 2.4 ratio and perhaps a 45 percent win rate, gives 0.45 times 45 minus 0.55 times 19, about 9.8 pips. The lower ratio can easily produce the better result.

Tying the buffer to hourly ATR is a good principle, since it adapts to current conditions. In a quiet market with an hourly ATR of 6 pips, a quarter ATR buffer is 1.5 pips. In a volatile market with an hourly ATR of 20, it's 5 pips. A fixed buffer of 3 pips would be too wide in the first case and too narrow in the second. The choice of timeframe for the ATR should match the timeframe of the setup. For a setup on the hourly chart, the hourly ATR makes sense. For a four hour setup, the four hour ATR would be more appropriate.

The MAE method mentioned is the best way to choose a buffer from evidence rather than theory. Recording the maximum adverse excursion of winning trades shows how far price typically moves against good trades before they work. If 80 percent of winners never move more than 8 pips beyond entry, a stop at 10 or 12 pips would preserve most of them. If many winners moved 15 pips against first, a tight stop would cut them out. The MAE table thread elsewhere on the forum walks through this calculation step by step.

Spread is worth adding to the buffer calculation for shorts. A short stop is triggered by the ask price, which is above the bid shown on most charts. If the spread is 1 pip, a stop at 1.1112 on the chart will trigger when the bid reaches about 1.1111. During spread widening, it could trigger earlier. Adding the typical spread to the buffer avoids being stopped by the spread alone. Has anyone here tested different buffer sizes on their own trades? I'd be interested in what share of the hourly ATR worked best and whether it varied between pairs.