Wednesday, March 20, 2013

Winners and losers

One of the things I encourage when assisting or mentoring other traders is regular dialogue keeping me up to speed with their wins and losses, and more importantly how their mind deals with the inevitable slings and arrows that the markets throw at us. As should be clear from many posts on here, I believe that having your risk under control greatly assists a trader in keeping an emotional equilibrium when participating in the markets.

It is always nicer to receive emails such as the one I received this morning from someone who has been trading the system for a while now. I had the pleasure of holding a webinar a few weeks ago where he attended and we finally got to talk about his progress. He mentioned one or two positions, which he is still holding as of today. I've shown the charts of these below:

These particular set ups are not out of the ordinary - the system scans used does a great job of identifying setups that can develop into trends such as these. The good thing about these trades is that he has resisted the termptation to take profits too early, and has been able to sit tight in these positions as the profits have grown, while updating his trailing stops as required along the way.

On the other side of the coin are the losses trades that people suffer, and in particular those where price gaps down through your intended stop level, meaning you suffer a loss greater than anticipated.

I've shown a chart below of one such stock that a trader I know was in. The large candle down today is slightly misleading, as price did gap down on the open this morning. This particular move resulted in a loss greater than 2R. Price movements such as this highlight once again the need for prudent risk control when trading in the markets. Fortunately this particular trader has a strong respect for risk, as well as having developed the required mindset suited to trend following. As a result did not suffer a huge drawdown as a result, and is able to see this trade for what it is - a perfectly good set up that did not work out.

A price movement such as this is why I set out the case for a conservative initial stop placement in the addendum to my e-book. The comments I have had from those trading the amendments is that losses and drawdowns (in terms of R) have already been reduced, improving the overall expectancy of the system.

However, this should not mean that you automatically attempt to place your initial stop closer to the entry price, even thought this would further improve the possible reward to risk ratio - certainly if you were considering doing this, then you should reduce the percentage you risk on each position. When a gap against you occurs, this also means you could suffer an bigger loss as a consequence. If you want the rewards, you have to accept the risk. In this particular example shown above, had the advice in the addendum not been followed, then a loss greater than 4R could have occurred.

In cases like this, all you can do is to ensure is that:

a) You continue to take new positions where the setups are per your specified criteria (i.e. they are 'good bets'); and
b) You maintain a healthy respect for risk, ensuring you do not suffer too badly when a price movement such as this occurs.

One of the elements to being successful in trading is that you are able to accept that losses occur, sometimes greater than anticipated or intended. But again, this is only likely to happen if your risk parameters are set at sensible levels.

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