In the March/April edition of Educated Analyst, we considered the benefits of trading multiple contracts with an approach that I refer to as the Single In/Scale Out method. If you didn’t have a chance to read that article, please do so as this article will pick up where we left off. Before we discuss the mechanics of how to liquidate the last contract of the Single In/Scale Out method, we will first discuss the use of the 3 Bar trailing stop.   
   
The 3 bar trailing stop is a useful mechanical device to liquidate an open position in an orderly and disciplined manner. To calculate a 3 bar trailing stop, look at the last three complete bars displayed on the chart. Complete bars are ones that are static or are not still in the process of being painted on a chart. If your position is long, you will be looking for the lowest low of the last three complete bars. If you are short, you will be looking at the highest high of the last three complete bars. It is just beyond this high or low that you will place your stop Typically, we will put a stop one tick beyond this high or low bar. The only caveat to the above rules is that you cannot include inside bars in your calculation of the previous 3 complete bars. An inside bar is a bar where the range from the high to the low is within the range of the bar that is immediately preceding it. Remember it can only be an inside bar in relation to the bar immediately to it’s left, not in relation to the bar two bars ago or three bars ago. Also a reminder for candlestick traders; we do not care about the opening and closing prices with this trailing stop, it only considers the extreme highs and lows. An example of an inside bar can be seen here in Figure 1; Notice that the range of the bar that is marked as an inside bar is inside of the range of the bar that is labelled as bar 2?  
 
In Figure 1 we are going to calculate a 3 bar trailing stop on a short trade. Working from right to left we are going to count back 3 bars and label them on the chart. The first bar on the right we will label as bar number 1 as this is the last complete bar on the chart. The chart is daily and regardless of whether a new bar starts to paint on the chart, we will not use any of that new information in the calculation of our stops. Notice that bar number 1 is not an inside bar, so we will label this bar as the first bar of three.  Working from right to left, notice that the bar immediately to the left of bar number 1 is an inside bar so we will not include that bar in the 3 bar count. Working again from right to the left, we see that the next bar is not an inside bar so we will label that one as bar number 2. Proceeding to the next bar to the left of bar number 2, we find a bar that is not inside the range of the bar beside it, so we can count that bar as bar number 3.

Figure 1: 3 Bar Trailing Stop with Inside Bar

As mentioned, we are short in this silver trade so we now need to find the highest of the three bars that we have labelled. As you can see, bar number 3 is the highest high of the three bars in question, so this will be the place to put a stop. The assumption is that the downtrend would be over if the market takes out the high of bar number 3.

One piece of advice/ don’t put your stop exactly one tick beyond the range of the bar if the number ends with a 5 or a 0. Put it just beyond the range of the 3 bar high or low, and pick unusual numbers that people don’t typically use such as 67 or 74 or 38. This reminds me of bidding on Ebay. If you’ve ever bid on something at Ebay, have you ever lost to someone that outbid you by 1 cent? This happens when we put in a maximum bid on an item with a number such as $20.00. The experience “Ebayer” knows that some inexperienced bidders will bid at $20.00, so he puts in a maximum bid for $20.01 and wins by a penny. This also happens with trading. So in view of the foregoing, if you were long and thinking of putting a sell stop in at $20.00, change it to $19.86 or $19.93 or some other random number to avoid getting stopped out unnecessarily. 

Going forward, as new bars continue to be added to the right side of the chart, there will be a need to recalculate our 3 bar trailing stop to determine if the stop is still on the highest high of the previous three bars. Eventually, the market will exceed the highest high of the previous three bars and you will be stopped out. The result of the trailing stop that we initiated in the trade above can be seen in the chart below in Figure 2. I left the 1, 2, 3 labels on the screen so that you can see where we put the trade on. The crooked line displayed above the highs is an automatic X bar trailing stop available as part of the Beck Tool Group add on module available through Market Analyst. In this example you would have been stopped out based on the high of June 26, 2009.

Figure 2 : 3 Bar Trailing Stop Indicator

To manage the last position of our Single In/Scale Out Method, we will use a three bar trailing stop but we are going to use it on the next larger time frame. Our initial trade set up was on the daily chart, so now we are switching gears to the weekly AUD/USD chart. As you can see below in figure 3, the Gartley Pattern is still visible and I have included the profit targets and stop levels for our single in/scale out strategy.

Figure 3 : Changing from Daily to Weekly

As noted on the chart above in figure 3, if we use a three bar trailing stop, we have to look back at the last three complete weekly bars on the chart to determine where our stop should be located. The lowest low of the previous 3 weekly bars is the low of bar number three at .6853. Notice that this low is below our entry price of .6910. With that being the case, we will not employ the three bar trailing stop on our weekly chart until it exceeds our entry point at .6910. In other words, until the three bar stop is above our entry point, we won't use it. The idea is that we don't want to lose any money on the remaining contract; so that means that the three bartrailing stop will only kick in when it is above our entry point. The chart below, figure 4, shows us when the three bar trailing stop begins to take effect.
 
In figure 4 we can see that the three bar trailing stop on bar number 3 is now above the entry price of .6910. Now the 3 bar trailing stop kicks in on the weekly chart, and we have our "lottery ticket." The result is on the next page in figure 5.

The line shown under the bars in figure 5 is an automatic 3 bar trailing stop available in Market Analyst. The 3 bar trailing stop on the weekly AUD/USD would have kept us in the trade for over three months until we took off our last position at .7680.  

Figure 4 : 3 Bar Trailing Stop Above Entry Price 

To review these two articles on the Single In/Scale Out strategy, we had an initial risk of 450 points. Hitting the first target paid us 75 points and reduced our risk to 75 points or 83%. The second target paid us 150 points and our stop was move to entry, thus theoretically eliminating the chance that our profit would turn into a loss. The last position or "lottery ticket" was liquidated for a 770 point profit. The single in/scale out strategy works well in all markets and all time frames. Regardless of what trading system you like to use, do yourself a favor and start using the single in/scale out money management strategy with your existing trade setups; you will be glad you did!

Figure 5 : In Scale Out Strategy 

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