“Rolling It Forward” for Profitable Trading (Part 3)

03/26/2010 12:01 am EST

Focus: STRATEGIES

Timothy Morge

President, MarketGeometry.com

Here is a set of five consecutive trades I took in the 30-year bond futures. You can see the chart that spawned the last trade in last week's MoneyShow.com article: “How to Develop Your GPS for Chart Reading.”

chart
Click to Enlarge

The first thing you should note is that I am using much less leverage than the trader in the first example. And I am using smaller consistent stops for each trade. I don't have to use all five ticks, but I like to hide my stop order behind market structure, and that generally takes all five points.

Now look at my planned or initial risk/reward ratios: 6:1, 8:1, 4:1, 3:1, and 8:1. By looking for trades that realistically have initial risk/reward ratios of better than 2:1, I am able to withstand two or three (and maybe four) losses in a row without doing much damage to my account. How do I know if the initial risk/reward ratio is realistic? Here are the actual outcomes: 3:1, loss, loss, 3:1, 9:1. There is nothing I can do about the losses, but if my winning trades had actual risk reward ratios of 0.5, 1.2, 1.6 when I had been looking for 3:1, 4:1, or 8:1, it would be time for me to re-evaluate how I was choosing my initial profit targets.

By using consistently sized, smaller stops, the two consecutive losing trades didn't take my account into negative territory. And here's the key: In the first trade, I “rolled forward” three stop losses. That means that when I took a profit of 15 ticks in the bonds on that first trade, I had 15 ticks in my account as padding against a string of losing trades. Since I was consistently using five-tick stops, I could have lost five ticks on the next trade and only been back to break even. I still would not be feeling the pressure of needing to make money to recover from large losses.

As I said last week, a picture is worth a thousand words. Let me show you what rolling forward stops looks like.

chart
Click to Enlarge

This spreadsheet says it all. You can see how many ticks I have added to my account after each winning trade and how many I lost from my account after each losing trade. The center column shows you how many losses I have rolled forward, and finally, the last column shows you how many losses I have left in my account before I begin to draw down actual capital from my starting levels.

By using consistently sized, smaller stops, even if I had started out with two losing trades, with a solid risk/reward ratio of 2:1 or better, my third trade would have easily covered the losses from the first two losing trades. Don't dig big holes! Trust me, they are much harder to fill up! Trade with consistently sized stops, use smaller leverage, only take trades that make sense, and just keep rolling forward those stops.

The goal is to become a consistently profitable trader. And that means three or four winning months in a row, and the losing months should be barely negative because you are controlling those losses!

Here's the secret to having a winning month: At the end of week three, if you have 13 losses rolled forward, it is extremely likely you will have a nice winning month. There is no pressure left for the rest of the month, so you can relax and trade free! And once that winning month closes, you have positive momentum to start the next month out with. Keep the same stops, the same risk/reward ratios, and the same realistic profit targets and do it again. Before you know it, you'll be on your third or fourth winning month. You'll be a consistently winning trader!

Just keep rolling them forward!

I wish you good trading. Read Part 1 | Read Part 2

By Tim Morge of MarketGeometry.com

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