5 Ways to Break a Trading Slump

01/27/2012 7:30 am EST

Focus: TRADING

Losing streaks can—and will—happen, explains Cory Mitchell, but by asking these five questions, the trader can identify whether a flawed plan or strategy is the problem and take steps to correct it.

A "trading slump" is invariably endured by almost all traders at some point in their trading experience. A trading slump is a point in time where profits are elusive, or losses may even be mounting.

These losing or unprofitable streaks can happen to anyone at any time. It may occur because the market has shifted in some way. At other times, it may be because the trader has altered a strategy or is no longer adhering to a trading plan.

No matter the reason for the slump, there are five questions a trader can ask to help isolate the problem so changes can be initiated, and hopefully, a return to profitability will ensue.

The following questions should be answered as honestly and as fully as possible. Each will probe current market conditions and will require the trader's own strategies to be scrutinized. Traders should also realize that losing trades happen to everyone, and even the best trading system can experience a string of losses.

Trading rules and strategies should not be questioned every time a losing trade occurs; these questions should be used when the trader is in a sustained period of unprofitability. Being aware of these questions should also keep traders on course at all times, helping to avoid "ruts" in the first place.

Is the security I am trading moving in such a way that it is even possible to produce a profit based on my methods?

Markets continually shift from low to high volatility and back, and ranging to trending and back again. Therefore, what works in one set of conditions may not work in another. A plan may be executed perfectly, but if executed in the wrong market environment, it will likely be a losing endeavor.

Therefore, traders must consider if their entry points, stop levels, profit targets, and money management strategies are viable in the current market conditions. If not, then the trader should avoid trading until conditions are more suitable, or create alternative strategies for the conditions.

See related: What Not to Do in Volatile Markets

NEXT: Trading Against the Trend

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Am I trading against the trend or with it?

Many traders develop strategies to capitalize on trends. Trends occur on different time frames, and which trends are currently relevant should be noted by the trader. Trading with the trend can be subjective in that a short-term trend is going one way and a longer term trend going the other. Therefore, being aware of multiple trends and deciding which ones to trade is a crucial factor in trading success.

If a trend following strategy is being used but is not profitable, traders must consider if the market is even trending. If a trend is occurring, the entry point is possibly too late (close to a correction point) in the move, or stop levels are too close to the price.

If the strategy appears as if it should be profitable (but isn't), are the rules of the strategy being adhered to? It may not be the strategy but rather the trader's lack of discipline which is the problem (which is quite often the case).

Do I have a set of written rules for entries and exits and am I following these rules?

If a trading rut is occurring, it could be because the trader doesn't have a detailed plan for how to enter and exit positions. Are entry and exit rules written out in detail? The details should include how and when trades will be entered and exited.

See related: Find the Entry/Exit Strategy That Suits You

Traders must also question if they have made any small changes in how the plan is traded. An example is entering in real-time as a signal occurs, as opposed to waiting for the close of a price bar, or vice versa. Such a change could shift the dynamics of a strategy.

Also, have the entry and exit rules been tested in some fashion? Or are the rules based on unfounded assumptions? Strategies can be tested through backtesting, paper trading, or a demo account if the viability of a strategy is questionable.

Am I trading all my signals or only certain ones?

When systems are created, especially if backtested, there is an assumption that all the signals produced by the strategy will be traded. If certain trades were filtered out of the results, these same trades should be filtered out in actual trading. Therefore, the trader must ask "Am I following my plan or am I making too many—or too few—trades?"

If additional trades are taken that are not part of the trading plan, the plan should not be blamed. The trader should cease these excess trades until these trades can be incorporated into a profitable system.

If all the signals are not traded, this could drastically skew the profitability of a strategy. Traders should check to see if the trades being skipped are profitable ones. If so, trade the signals.

NEXT: Improper Risk Management Techniques

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Have I created risk management rules, and am I following them?

One of the most important aspects of trading is money and risk management. Each trade should only expose the trader to a very small amount of risk, ideally less than 1% of the trader's capital. Therefore, if money management rules are in place, are the rules being followed?

See related: Tough Talk About Risk Management

It is possible that rules may be in place, but in actual trading, do losses end up larger than originally planned for? Slippage, or fees, can result in a loss being larger than anticipated, and can wreck a profitable strategy if risk is not properly accounted for.

If losses are continually slightly (or greatly) larger than anticipated, reduce position size (even to a single share, if that’s what it takes), switch to a broker with lower fees, or stop trading a market where there is so much slippage that risk controls cannot be properly implemented.

See also: The Steps to Proper Position Sizing

The Bottom Line

A losing streak can—and likely will—happen to anyone if trading for a long enough time. A rut can be caused by changes in the market or in how a trader implements their rules. By scrutinizing their system, the trader can hopefully isolate the issues causing the string of losses so it can be fixed. Monitoring markets and determining if the system will even work is one way to do this.

A trader should also monitor if they are trading with the trend or against it; if they have entry, exit, and money management rules in place; if all signals are being traded; and most importantly, if all the rules in place are being followed.

By examining the market and scrutinizing the trading plan (and how it is implemented), it is likely the cause of the "rut" can be found and the appropriate action taken to remedy the situation.

See also: How to Break a Trading Slump

By Cory Mitchell, contributor, Investopedia.com

Cory Mitchell is an independent trader specializing in short- to medium-term technical strategies. He is the founder of www.vantagepointtrading.com, a website dedicated to free trader education and discussion.

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