Hello traders! In honor of baseball season, this week’s newsletter will reference America’s favorite pastime. The main point of this letter is setting realistic expectations on your trades and managing your winners properly. After speaking to several students over the years, there has been a relatively consistent topic that comes up, which sounds something like this: “I get into a trade and it goes my direction, but after a while it goes against me and I get stopped out.” My next question is always “How far does it go your direction?” Usually the answer is something like “20 pips” or “the distance of my stop loss” or some other metric that they are using.
Guess how far these traders are getting on the diamond in baseball? That would be “first base”! In trading, very often experienced traders will have multiple targets for their trade. If you are trading 3 lots, basically you could have three potential targets to exit this trade, perhaps 20 pips for one lot, 50 pips for the second, and 100 pips on the third. If you are consistently hitting your first target before price retraces, you are hitting consistent “singles” in baseball, getting you to first base! Many new traders only want to hit the “home runs” with their trades, making dozens if not hundreds of pips on a trade. In our current market volatility, not everyone is good at hitting these home runs. You would be surprised how many traders I’ve spoken to who stubbornly watch a 20-50 pip winner turn into a losing trade, by letting it retrace all the way back to their stop loss! Instead of going for only the home run, if these traders would take part of their trade off at a smaller first target (a single) and moved their stop to break even, there would be many more dollars in their account today!
Have you seen the movie “Moneyball”? Brad Pitt and Jonah Hill played the general manager and “consultant” to the Oakland Athletics baseball team in this film. They took the uncommon view that hitting percentages were less important than on base percentages. This means that instead of looking at big name, expensive players who hit a lot of homeruns, they looked at players who got to first base consistently. If you are a fan of baseball, you know these numbers can be wildly different! When a team is trying to score runs, having people on base is a lot better than waiting around for some slugger to hit a home run every other inning! The point is, getting to first base consistently is more important than trying to hit big home runs every time you are at the plate!
So how can we relate this to becoming a better trader? When you find a trading style that you like, be it scalping, momentum, swing, or position trading, you will probably find that you are going to be “in the money” a few pips on most of your trades after a period of time. For example, if you find yourself as an intraday momentum trader, you may be going for 20, 50, and 70 pips on your trades.
Should you stubbornly hold on to your entire position until it hits your 70 pip target? In my opinion, no. This would be considered a home run! First things first, let’s lock in the “single”-perhaps take one lot off at the 20 pip target and move your stop loss to break even. If price retraces, you still made a few pips. If not, then perhaps you will get a double (getting to second base)at your 50 pip target! One way that people move their stop is to wait for the price action to move in their direction the distance of the stop loss-with a 10 pip stop, when in the money 10 pips the stop is moved to break even. My personal preference is to wait until my first target is hit. Try both techniques and see which works better for you.
Imagine a batter who hits the ball, and doesn’t start immediately running to first base. Instead he stands there at home plate, waiting for the ball to drop before he starts running. As far as I’m concerned, this is like letting the trade work without moving your stop and locking in profits! Everyone in the ballpark would be screaming at this batter to start running if he just stood there, waiting for the ball to land! Doing that, it had better be a home run! Otherwise, he will get thrown out not even getting his single. Trading is the same way. Take those singles, then doubles, even triples, and if a homerun shows up, congratulations! There is a reason that homers are not hit at every at bat by every player. They aren’t very easy to do! Let’s concentrate on getting on base and managing our winning trades by moving our stops when price goes our direction. If you consider yourself the general manager of the baseball team, moving your stop is like managing your players properly. Four singles by four batters in a row will add up to a home run!
Please be aware that I am not going against the idea that you should have at least a 3:1 reward to risk ratio on your trades, or to ignore our previously discussed supply and demand zones. These should be the cornerstones to your trading plan! I am only suggesting that because of these volatile times, managing your trades in a slightly different fashion may put more pips in your account.