Monday, October 21, 2013

Scratching trades quickly - its ok to be wrong

I've shown some old charts below, not to show how profitable some trends have been, but to show how you should pay heed to what the charts and price action tell you when a move to a new high or low fails.

Using price channels such as those shown on my charts give a clear indication of when price has moved into new territory, potentially denoting the start of a new trend. However, as we are often told, these types of trades are prone to failure. Both the charts show where there have been such attempts made, only for price to quickly fail (quite often on the day of the attempted breakout, or the day after), and, in a lot of cases, for price to move and attempt to breakout in the opposite direction.

Even if your win rate is less than 1 in 2, paying attention to these entries and whether they quickly move as anticipated can cut down on having your capital stuck in sub-optimal trades that are going nowhere. More often than not, if a breakout to a new trend is going to be successful, price will move and not fall back into the pre-entry price zone, or will retrace to that level before reverting back in the intended direction - for instance, in a long trade this would be a classic example of a prior resistance level now acting as support.

Therefore, you do not have to wait for a 'slow failure' to occur. You do not have a finite amount of capital - you are therefore limited to holding a certain number of trades. There is no shame in closing a position on the same day it is opened, if price does not act in the manner you hoped. On the contrary, that also shows you are comfortable with the fact that, to make money in the long term, you are happy to take small losses while trying to find a profitable trend. You should keep an eye on those equities though, as they may give another signal within a day or two, at which point the intended price movement does develop.

However, to generate the overall positive expectancy, you must ensure that, if you are in a position where a nice trend does develop, that you ride it until the appropriate exit signal is given.

One final point - remember when trend following that the majority of your positions over the course of the year will cancel each other out - small losses covered by small profits. It is the remaining trades where a decent trend materialises, that generates almost all of the overall profits. Scratching those 'failed' trades as soon as possible when they do not act as intended, or ensuring that profitable trades do not revert to a loss making position will help you in achieving your goals, as well as help keeping you on an emotional even keel.

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