2 Important Things Forex Traders Should Learn
02/12/2013 9:00 am EST
You should learn to hate large losses more than you love big winners because large losses will keep you from trading for a living, writes Rick Wright of Online Trading Academy.
A common phrase in sports that has been attributed to several people is: “I hate losing more than I love winning.” In the sporting world, the meaning is pretty obvious—you basically expect to win, and if you lose there is an unexpected and negative outcome which you apparently dislike. But how does this phrase relate to the world of trading? In two ways, actually.
In every Online Trading Academy class that I teach, the topic of managing your trade comes up at least once. In class, several different ways to manage winning trades is demonstrated. How do you manage a losing trade, you ask? Let the market take the price to your stop loss. Not all, but certainly most, of my small losses are when the market didn’t do as I expected, so I took the small loss. So managing a losing trade is easy enough—just don’t add to them! Occasionally I will take myself out of a trade before my stop is hit. The reasons are varied, but the easiest to explain here is this: when trading a currency pair that lags another—that is, doesn’t move at the exact same time, perhaps a couple of candles of lag—if the leader changes direction and I expect the laggard to then follow past my stop loss, I will exit the trade before the stop is actually hit.
Managing your winners can take many forms. Some traders use pure supply and demand as profit targets, and the trade is done. Others may use a close below a trendline, others a close below their favorite moving average, perhaps even an overbought/oversold reading on their favorite oscillator. During the trade, you are never sure which technique is going to lock in the most profits. After the fact is always very clear! One of my preferred techniques is to use steeper trendlines in conjunction with supply and demand. A fast moving market will cut through previous supply or demand zones, but using a trendline break at a zone will give me satisfaction that I have captured most of the move.
In the following chart, a trader could have gone long in the demand zone marked DZ. Each of the supply zones (A, B, or C) could have been a legitimate profit target when you follow our core strategy rules. As the price action rapidly approached these zones, the trader must ask him/herself where to take profits. In the blue ellipse marked on the chart is one possible location to exit a trend following trade, as price closed below the trendline. A few candles later, price went higher again to the supply zone C, but then rapidly fell away. If the trader waited for a break of either trendline 1 or 2 to exit this trade, they obviously left a lot of pips on the table!
NEXT PAGE: What’s More Important?|pagebreak|
So back to our question, which do you hate more? Giving back a few pips on a winning trade as price retraces and breaks your trendline, or missing out on more pips if price action keeps moving in your direction? Personally, I hate giving back more pips by not carefully managing a fast moving winner. I would much rather miss out on those last few pips at supply zone C, than give back all the pips waiting for the break of trendline 1 or 2!
The sooner new traders realize that buying at the very bottom and selling at the very top is an exercise in futility, the easier trading becomes. Who cares if you don’t buy the absolute low and sell the absolute top? Many professional traders have said something to the effect, “give me the middle half of the move, and I’ll laugh all the way to the bank.” Taking 100 pips from the middle of a 200-pip total move is still a nice trade.
The second topic in today’s article is based on percentages of your account. In my humble opinion, this is by far the more important. Every trader who expects a long career in trading should adopt this hatred! If you have a per-trade loss limit rule, for example 1 or 2% of your account, do you hate to lose 3% more than you love to earn 5% in your account? Think about that for a minute. If you would really love to make 5% on a good trade, yet be somewhat ambivalent to losing 3% (breaking your rule!) you are doing it wrong. Breaking trading rules, and taking larger losses is what losing traders do. Their careers as professional traders will be short.
Trading for over 15 years and teaching now for about seven has certainly ingrained this truth in me: taking large losses is the fastest career-ender that exists. The old phrase, “Manage your losses closely, the winners will take care of themselves,” comes to mind. In every class that I teach, at least one new student has blown up a trading account (or three)! The common denominator in these blown-up accounts is large losses. If your account loses 50% because of a few bad/large losing trades, what do you have to earn to just break even? That would be 100% on your remaining balance! Earning 100% is not the easiest or fastest thing to do, let me assure you. If you take a $10,000 account down to $5,000, you are doing something wrong. Go back and examine your trades; I bet your ratio of average wins to average losses is terrible. In class we recommend looking for trades that have a 3:1 reward to risk ratio. If your realized trades, the ones that are actually completed, is 1:3 or even worse, I hope your resume is updated! Trading will be a short job for you.
The bottom line is this: you should learn to hate large losses more than you love big winners. The big winners are just part of the job, pat yourself on the back for two seconds and move on to the next trade. Large losses will keep you from trading for a living, or even make you go back to work for someone else!
By Rick Wright, Instructor, Online Trading Academy