Monday, April 02, 2018

The payback for following your rules

Quite often I get into a trade where price starts moving nicely in my favour, before reversing and taking out my stop, leaving me with either a significant erosion of open profits, or may be even taking a small loss. 

Not very interesting or exciting I know, but that is what following my rules allowed me to get.

What following my rules also does for me is avoid the siren call of hanging on to my position, in the hope that price would reverse back in my favour. I can look back at lots of examples in my own trading records where keeping such a position open would have been a expensive mistake.

To me, this is one example of why traders should never let their opinions or predictions of what they think or hope may (or may not) happen cloud their judgement in the markets. 

In my case as a trend follower, this is the cost of my rules allowing price some 'wiggle room' before the trailing stop gets hit. And by definition, trend followers never get out at the extreme of a price move - there is always an element of giving back some of those open profits.  

That is the compromise to avoid cutting your winning trades short. 

But it does mean I don't end up in a situation where a small loss has the potential to turn into a far bigger loss.

Following on from that, is what to do about trades where it seems almost too easy - you get into a position where price is moving further in your favour, day after day. 

Most net losing traders who try to utilise a trend following method can cut their losses, but they also end up cutting short their profits, from a basic fear of losing what open profits have been made.

In this type of scenario, you may possibly think price has moved too far - or that you think you will be 'smart' and try and time the extreme of the move. Who knows, that directional move you have got into may only just be starting...

Or you may have suffered a run of losing trades, and feel you simply need to bank some profits to stop the bleeding.

What if price continues to move in the direction you were trading after you have bailed out? Had you held on (in the absence of an exit signal being given as per your rules), that one trade could have covered a whole bunch of losing trades, and may have left you an overall profit - it may even have made your whole year!

A trader I know recently closed a profitable long trade on the Dow ETF $DIA, which had been kept open for almost 500 days! That's patience and discipline for you.

Allowing your entry and exit rules to determine when you get in or out of a market always pays dividends in the long-term, and is proven to help you avoid making those costly mistakes that hold you (and your equity) back.

Yes it is boring. It means being disciplined in what you do. But trend followers do not trade for excitement - they trade to win.

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