Thursday, September 14, 2017

An example in trade management - the trailing stop

When trading using a clearly defined set of rules, it can easily become frustrating for an inexperienced trader to get stopped out of a position, only for price to then reverse and start moving back in the direction of your trade.

Some see that as a weakness of their method. Yet I, and many other traders who religiously follow their rules (be they automated or not), see that as a strength. 

For every one trade where you suffer this scenario, there is another (if not more) where you can look back a few days or weeks after the event and see that price had carried on moving in the opposite direction to the trade, and by following your rules you actually ended up getting a far better result than if you had overridden the signal and stayed in the trade.

You created the rules that you use, and assuming they have been proven to generate a positive expectancy - why on earth would you want to override them? That is just madness.

One such example trade is that of gold, which I have talked about here. Today the trailing stop was hit out on an intra-day move, only to subsequently see price start trying to reverse again (chart below). The end result was a profit banked of as near as damn it +1R.

We will need to wait to find out if price will move up or down from here - I do not have a crystal ball that works, and to be honest I don't care. 

All I am bothered about is being disciplined, following my rules, and accepting whatever the markets throw my way.

I know that, if I follow those rules consistently, then over a large sample of trades, the results will follow. And that should be your approach too. 

It's just one trade out of potentially the next 1,000 or 10,000 trades. Richard Dennis once said that 95% of his profits came from just 5% of his trades, and I have found that to be the case too. The vast majority of trades are small winners and small losers (due to strict risk control and the cutting of losing trades), which cancel each other out. 

So when we lose, it should make no difference from an emotional or risk control perspective. It just bring us one trade closer to a big winner.

Overriding your rules can set a dangerous precedent, particularly if you end up making a larger profit, or avoiding a loss. Your mind will accept that its ok to override your rules. 

That may work once or twice - if you're lucky. And then a trade will come along where you will not take the exit signal your method gives you, because you think you are 'smarter' than them, only for price to start moving significantly against you...