Taking losers... This was written from a short term trading perspective long ago. It assumes discretionary trading is taking place, but now, I would simply say: Back-test a plan and only trade it if it the data gives you a long term positive expectancy. Some of this logic would still apply, but
a plan should be followed meticulously, otherwise the data is invalidated and so is your expectancy. I don't think I ever posted it so here goes.
When you buy clothes for work, should you feel like it was a waste of money? No, because its that purchase that allows you to dress properly so you can perform your job and get paid.
When a business owner buys materials for their business, should they feel like it was money down the drain? Of course not. Without raw materials, a business cannot make products to sell and produce a profit.
So then why when trading, do we fear loss of capital so badly? It is because we fail to see that loss for what it truly is. It is a counter-intuitive principal that must be understood. When the entire purpose of trading is to make money, it feels completely against the point to lose money doesn't it?
You must come to understand that losing trades are an unavoidable cost of doing business. You must view the losing trade as the one and only way to make yourself available for the opportunity to make money in the long run.
As with any business, there is overhead and the less overhead a business has to pay out the more profitable that business can be. In trading the overhead of a losing trade is unavoidable. There is no magic way to never lose in trading, without doing something illegal.
In most businesses monthly rent must be paid to keep the opportunity to welcome customers... In trading, losses are like the rent. It is the risk you must take to attract the paying customers.
In the business of trading, you employ a method of your choosing to extract money from the market. Every method will experience both winning and losing trades, but the only way to have success with any one method is to make sure that over time your average dollars won outweighs your average dollars lost.
It sounds very simple, and it is, but how do you know that your method is able to do this? Back testing. Back testing is the process of using past market data to apply your methodology and obtain performance data.
Through a large sample size of trades you will then have the data to determine very specifically your winning percentage, losing percentage, average size winner and average size loser.
When you run those numbers you will then find what kind of performance your system is likely to experience in the future. Note that I said "Likely". The past is never guaranteed to repeat itself into the future exactly, so at best we have an insight as to how any particular method might perform. The more trades you produce through as many different market conditions you can test them through, the more accurate your data will be.
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As in any business we hope to make the most money possible as fast as possible, but what happens in the real world when an item is not selling? What is the market telling us?
"The price is too high" or "I don't agree with your valuation".
In the real world, if an item isn't selling (considering it is of quality) the price is lowered to entice sales so that a profit can still be made (
or as little loss as possible) rather than it sitting on shelves and making a total loss.
In trading, we have to listen to what the market is telling us very closely. When we set out to trade, we can often have a goal in mind of a certain percentage or dollar value we would like to see out of that trade. If we have taken some losses that day, the natural tendency can be to expect making it all back in the following trade so that our goal is met for the day/week.
We must keep in mind that the market is unaware of our goals, Unaware of our previous losses, and even if it were aware, would not care.
Just like the store owner who may have overpaid for a shipment of a certain item for any number of reasons, the market will only bear the price it is willing to bear. If the store owner must sell his product at a 10% premium than normal to make a profit, there is a likelihood that shoppers will not buy it at all! They are not concerned with the sellers cost, they are concerned with getting the best deal.
How does this apply to trading? When you are down a few bad trades and hoping to make it all back and then some on the next trade, the market might have other plans that don't consider your unfortunate position. You don't want to get caught holding on to a winning trade beyond what the market is willing to give you.
"How do I know what the market is willing to give me?"
The truth is You don't. At least not until after the fact. But, just as back testing can produce evidence of a particular future outcome (average winning trade size) you must realize that the market itself is a dynamic flowing picture of the present mind of consumers and very recent movements can indicate movements in the very near future. When a recent price hits a price level and starts to drop, that is immediate feedback that the collective mind thought that price was too high for the immediate moment.
Depending on which time frame you are going to trade from, the "immediate moment" can be gauged from other very recent moments, or moments from years ago... it all depends on where the collective focus is at. And by collective focus, I mean collective dollars, because in this business the money is what moves prices, not necessarily the most people.
So if you are an intra-day trader looking for a few pips, it is best for your targets to be based on movements within the realm of a normal day. Keep the dreams of hitting the home runs at bay, as they can cause you to miss out on the singles!
If you have taken two 5-pip losers, you now need 10 pips to get back to break even. Lets imagine that price most recently hit a high that was only 7 pips away and you are in a long trade now and You've just made up for the spread.
Does the market know you are down 10 pips?
No.
Does the most recent market picture tell you that price was "Too high" 7 pips higher than it is now?
Yes.
The most productive course of action might be to simply take your profit 6.5 to 7 pips from where it currently is and bank a profit when that price level is hit again. Now, depending on how significant that price level is, the market will have varying probabilities of reaction upon reaching that price point again.
One other option, if you feel that price could actually break that recent high, is to take profits from a portion of your position when the high is reached. If the market does break that high and continue higher, you will still be in the trade and can manage it further. If the market happens to turn from that high, you made some profit and could have protected your gains by moving your stop loss to your original entry price or perhaps a pip or two higher.
just as letting go of a loser immediately is important to do, there are situations when in a profit that you must exit quickly as well. Imagine you are just entered the trade... is the market retracing quickly against you? GET OUT! If you are in a profit it may be time to treat it as if you had just entered. The price action is the price action and the market is not aware nor does it care about your entry!
If you get in and it moves in your favor, stay in until it stops. if it reverses get out!
