This Week’s Battle Plan

Self-assured — rumored to have walked into CNBC at height of bull
market, looked into mirror and started singing

Missing/Skipping Trades

What happens to most traders when they have three, four, or five
losses in a row? They either lower their position size on the next
trade, or worse, they just stand aside in order to “let the dust
settle.” Is this the correct thing to do? Is it best to lessen
position size or pass on trades until things become normal again? In
my opinion, it absolutely is not! In fact, I would argue that
these traders should be doing just the opposite — they should be
getting more aggressive during these periods, not less. But the
fear of further loss increases after each consecutive loss, and human
nature takes over. And human nature is a mechanism that looks to
protect the mind/body. And the way it protects is to logically say
“back off.” That may be fine in the arena of physical
confrontation, but it is wrong when it comes to trading. The markets do
not know that you have just taken multiple losses in a row. And,
in fact, if you trade the same style/methodology, each loss gets
you closer to a winning trade. This is true not only because
markets shift from trend to reversals, it’s true in a statistical
manner (if your methodology is correct 50% of the time, even though
each new trade has a random chance of being successful, each
consecutive loss moves it one trade closer to success).

But, what do most traders do when they take a few losses? They back
off. And it’s wrong. And, as we all know from personal experience, you
usually back off right before the trade that has an outsized move. A
trade that not only evens the score, it many times makes one
profitable. If you have a methodology that has a long-term edge,
you are likely killing that edge if you are backing away after a few
losses!

As you probably know, I have been mentoring TradingMarkets members for
the past half year. Last week, I graduated someone from the program
who does something better than nearly any trader I have seen (and
being in this industry for 21 years, I’ve seen many traders). What is
it that she does that so impressed me? She takes profits. On
the surface, this may not seem like much. But she takes profits in
most situations. Over and over again. Large gains don’t turn into
small gains. Small gains don’t turn into losses. And, when you do
this over and over again, it starts to add up. Because when you are
doing this time after time, the money goes into your pocket. And it
doesn’t disappear. If there is one weakness with this approach, it may
be that by taking profits so aggressively, you let the occasional
“home-run” get away. Many traders go onto “tilt”
when this happens. They start mumbling for days that “if only I
held onto that position I’d be rich today!” These traders tend to
forget the ones that they got out of before they collapsed on them.
They only focus on the negative and the trade that would have put them
on easy street had they only stayed with it.

In my opinion, scaling out of positions is a superior exit/trade
management strategy. What does that mean? In means taking partial
profits off the table as they present themselves. No member of
this site should have a strategy problem. There are many, many
strategies that are available to you on this site that give you an
edge. It’s locking in that edge that makes results vary. And the best
way to exploit these strategies’ edges is to take pieces off the
table. Lock in the gains as they come.

There are multiple ways to do this, and let’s use an example trading
one of my favorite strategies, “News Reversals.” A company
announces better-than-expected earnings before the opening. The stock
gaps higher on the news and then reverses. You short it at yesterdays
high, lets say at 26.78. Your protective stop is at today’s high of
27.10. What do you do now? Well, as the stock keeps dropping, you
start taking pieces off the table. Let’s say you shorted 1000 shares.
You might lock in profits on 300 shares when it reaches an equal level
to your risk (you risked 32 cents here). So you lock in profits on
these 300 shares at 26.78 minus .32 = 26.46. You then move the
remaining  700 shares to break-even, which is your entry price of
26.78. This guarantees you have a profitable trade. Then as the
market keeps moving in your favor, you start taking more off the
table. Let’s say the stock drops to 26.05, you might look to lock in
profits on another 300 shares and lower your stop on the remaining 400
shares. And from there, you will look to lock in gains on this final
piece before the close.

Some people (like me) prefer to let price take them out. Other
traders, like the member I mentioned above, like to use pattern
recognition, support and resistance etc., as their means to lock in
gains. Both choices are correct. And what makes them correct is
that you are slowly scaling out of a trade as it moves in your favor.
And are putting profits in your trading account each time you do this.

One final point here: I asked this woman if she minded the occasional
time when, after she exits, the stock keeps running and she leaves
money on the table. She immediately shot back, “No, it means nothing
to me. I’m already off to the next trade.” This is a very
healthy attitude to have. And it’s an attitude that will likely make
her a successful trader for years to come.

If you are letting big gains turn into little gains, and little gains
turn into losses, you do not have a strategy problem. You have a trade
management problem. And, by focusing on correcting this, and
exiting in the manner mentioned above, you can likely turn yourself
into a more profitable trader fairly quickly.