Locking is a type of a hedging strategy aimed at minimizing risks associated with changes in markets behaviour. The difference between hedging and locking is that hedging is used for different trading instruments, while locking is used for one trading instrument.
Locking is applied as or instead of the stop loss for limiting losses. The mechanism of lock setting is rather simple: if a trade is unprofitable, you set a pending order at some distance from the price. The tactics allow you to avoid losses and even close an initially unprofitable deal with a profit, provided that the price will return to the necessary level or the total volume of profitable positions will exceed the losses.
Let’s consider the popular profit locking strategy. This method is based on catching the price movements of 40-50 pips, so it can be successfully applied in intraday trading. According to the author of this method, you do not need to use any indicators. However, it is up to you. To begin with, it is necessary to learn some basic rules of limiting the risk:
1. The total volume of opened positions should not exceed 10% of the deposit.
2. The maximum number of open positions should be no more than 10.
3. The volume of the deposit should be no less than 30 lots. Here, we mean the ratio of the deal volume to the deposit amount. That is, if the trade volume is 0.1 lot, deposit should be at least $3,000.
How locking is set:
1. Place a pending stop order at the level of 30-40 pips from the price.
2. As soon as the first position is opened, place the second stop order in the same direction at the level of 10-15 pips away from the first deal and one more pending order of the same volume in the opposite direction at the level of 10-20 pips. You can also open the second pending order manually if the price reverses. Thus, a lock is formed that fixes the loss in the amount of 10-20 pips in case the entry is not successful.
3. If the order is opened, but the price moves in the opposite direction and hits the reversed pending order, you should move the pending order in the new direction of the price movement (i.e. opposite to the initial one) at the level of 10-15 pips.
4. Profitable positions can be placed at a break-even level by the trailing stop, and reverse stop orders that have not been triggered are moved by 10 pips from the next open position.
5. As soon as the sum of profit and losses becomes positive or negative with the minimum value, all the positions may be closed. In such a way, you can try to make more profit.
6. The volume of every opened position can vary, but the total volume of opened positions should be greater at the point where the price is moving to.
Here is an example of the described trading strategy:
The EUR/USD currency pair has pulled back from 1.2195 and is moving up. The buy position is opened in the volume of 0.3 lot. At the level of 1.2225-30, a buy stop order for another 0.2 lot is set as well as two more sell stop orders: 1.2200 0.3 lot and 1.2285 0.2 lot.
The price hit the buy stop order and moved to the downside, but having reached 1.2201, it changed its direction again. At 11: 00-20 GMT, after reaching the level of 1.2234, the pair began to decline again to 1.2200 where a sell stop was triggered. And then it turned upwards once again to hit the level of 1.2223. To sum up: the volume of buy orders is 0.5 lot, while the volume of sell orders is 0.2 lots.
At 14:30 GMT, statistical data is released. Here we choose the worst option, that is, do NOTHING until the release. We cancel the sell stop pending orders and wait for the news release. After that, we add positions within the direction of the price movement and do nothing with losing positions yet. As soon as the news is released, the pair falls rapidly.
The following orders are activated:
No. 1 sell stop 1.2200 0.3 lot
No. 2 sell stop 1.2190 0.2 lot
Now we add more pending orders:
No. 3 sell stop 1.2180 0.2 lot,
No. 4 sell stop 1.2170 0.2 lot
No. 5 sell stop 1.2160 0.2 lot
The price reaches the 1.2170 level, hits the fourth sell stop of 0.2 lot, and bounces back. Now, let’s close the positions: sell 1.2200 0,3 lot, sell 1.2190 0.2 lot (closing approximately at 1.2178-80). The profit is 10 pips for 0.2 lot and 20 pips for 0.3 lot.
The following positions are opened: 0.5 buy and 0.4 sell (sell from 1.2180 and 1.2170). The pair jumped to the level of 1.2287, but moved down again. Order No.6 - sell 0.3 at 1.2280-82 (at the closing level of sell orders or a couple of pips higher).
From the 1.2179 level, the price dropped once again.
Here, we are waiting for a further fall and add sell positions every 10-15 pips.
Sell stop No.7 - 1.2150 0.2 lot.
Sell stop No.8 - 1.2140 0.2 lot.
At the level of 1.2134, we have a buy position of 0.5 lot and a sell position of 1.1 lot. Now we can close all orders. As a result, we get profit in total.
Traders’ opinions on the effectiveness of the locking strategy differ greatly. Its supporters think that this method helps avoid losses, it is flexible, and does not require the use of any indicators or special skills in fundamental and technical analysis. At the same time, others believe that the strategy is useless in terms of all the mentioned criteria. They also mention the psychological factor and the risk of making big mistakes which can ultimately lead to the loss of the deposit.
The traders who successfully apply locks also have different opinions on the matter. Some consider them a last resort to rescue an unsuccessfully opened position. Others use locking as the main trading strategy. In both cases, traders often close with profit or at least reduce the scale of severe losses.
The locking method has significant advantages compared to the stop loss. Firstly, skillfully used locks can turn your losses into profit. Secondly, as a consequence from the first conclusion, the use of complicated market analytics loses its importance. It is rather difficult to predict the market behaviour even for the next hour. With the help of a lock, you can change the situation for your own benefit by simply placing the next pending order in the direction of the price movement, covering negative positions by volume. Thirdly, the essence of the technique and the described method is quite simple and obvious, so even a beginner can use them. Finally, the use of locking does not contradict the rules of money management, thus making it a serious competitor to the stop loss which is considered the main hedging tool.
On the other hand, this trading method requires a much greater deposit relatively to the allowed orders volume. As it was pointed out by the author of the locking method, it is necessary to have at least 30 working lots, whereas the ideal ratio is 100 working lots. So, a rather big amount of investments will stay on the account unengaged. Another disadvantage of locking is associated with money stuck on the trading account, that is, the long-term freezing of the lock. For example, when the price enters a flat channel with the market fluctuations of just 20-30 pips in both directions, it will be quite difficult to place a lock. Moreover, without proper skills, you can easily ruin everything. Opponents of locking say that in the same situation using the stop loss and increasing the volume of trades you can make more pips. This makes sense since the reverse orders with the increased volume and stop losses are commonly practiced and have proved their efficiency. Moreover, after the stop loss position is closed, a part of the margin is released, which makes it possible to increase the volume several times for a reverse order. With locking, however, every new order requires a new amount of funds.
Despite this drawback, many dealing centers allow you to open positions of the same volume, but in different directions, considering the margin for them as for one deal. It means that for 2 opened positions (buy and sell) on one currency pair in the volume of 1 lot, the margin will be $1,000 with 1:100 leverage instead of $2,000. However, most foreing dealing centres will not approve such deals. In this case, locking loses its meaning since the deposit will have to be increased several times in order to get significant results.
From a psychological point of view, the use of locking makes it possible not to fear losses, as in the case of a stop loss. On the other hand, this is where things can go wrong. If you open a huge number of orders, you may easily get confused, assuming that everything could be fixed.
These are the main things that the locking gurus pay attention to:
1.The number of allowed orders in trading should be limited to 10.
2. The total trading volume of open orders should be limited to 10% of the deposit or no more than 25% of the deposit.
3. It is necessary to constantly shift pending orders following the price movement (for reverse orders), or before the price for direct ones.
4. It is necessary to trace the price movements of at least 40-50 pips.