The article I published last week Monday (July 14th) titled - Trading Drawdowns - A Quick Overview provided a primer on drawdowns and position sizing. Today I will expand upon that and provide some, hopefully, helpful specifics.
Any trader who wants to last in this business has to respect the mathematics of drawdowns as we discussed. However, before we get into that let’s talk about minimizing the downside.
Oh’ Right…..The Stop Loss
Few other trading topics bring up such vastly different views. In my observation, most traders choose stop-loss levels that are not carefully considered or based on solid analysis. Instead, they fall victim to:
Stops just below a swing low/high
Stops that are simply too tight
Or worse - no stops at all
In my opinion, your stop loss needs to be the level at which your trade thesis (your premise for being in the trade) got blown out of the water.
Trading with Elliott Waves? Only choose stops where the wave count is invalidated.
Trading based on patterns like Gartley’s or the like? Pattern break-down is your stop.
Trading based on fundamentals? Your stop is when earnings have a big miss or Central Bank policies abruptly change
The key here is having a CLEAR and RELEVANT stop loss.
Size It Up
Once you know your stop loss you can select a lot/share size that will prevent you from exceeding your maximum risk on that one trade.
>This is Trading 101 and if you are not doing it already, you absolutely need to begin now.
So, you have your:
idea and thesis for the trade
lot size set
But that is not the end of the story.
What often happens next is that the trade, initially, might not go in your favor.
We have somehow been led to believe that we need to react, adjust, call your buddy or any other number of unhelpful responses.
Let me ask you a question. And this is an important question so take a PAUSE.
Absent some major world event, did the thesis for your trade get tossed into the scrap heap? Unlikely. More likely the market just does not see or agree with your take on things at that point in time.
Remember, until a trade is closed it is just an unrealized loss.
Did you know that some of the best CTA’s (Commodity Trading Advisors) - you know the ones who put up average annual returns of 20% - are routinely in a drawdown?
Yes. Not very fun. But that is what it takes to make it as a trader.
Ask yourself this question: How many times have you cut a trade because you simply were annoyed that it was not working, only to see it work out shortly thereafter?
If you are honest, probably a few times. To make it worse, your thesis did not change.
What changed was your resolve. Remember, on average, 80% of a trader's income is made a mere 20% of the time.
Just because the market is open doesn’t mean you need to be in it. It is not there to keep you busy and entertained. Be tactical. Here are the questions you might ask yourself:
Am I willing to let the position evolve/unfold according to my thesis and not stomp my feet or do something stupid if it does not work immediately?
If you answered yes to these questions and can stay disciplined and tactical, you are on the right path.
Any reviews, news, research, analysis, prices or other information contained in this article is provided as general market commentary, does not constitute investment advice and may undergo changes from time to time. Trading the Financial and Currency Markets on margin carries a high level of risk and may not be suitable for all investors. The high degree of leverage can work against you as well as to your favor. Before entering trading Financial and Currency Markets, you should carefully consider your investment objectives, level of experience and risk appetite. There is a possibility that you could sustain a loss of some or more of your initial investment and therefore you should not invest money which you cannot afford to lose. You should be aware of all the risks associated with Financial and Currency Markets trading, and in case you have any doubt, rather seek advice from an independent financial advisor. Scandinavian Capital Markets AB, its owners, employees, agents or affiliates do not give investment advice, therefore Scandinavian Capital Markets AB assumes no liability for any loss or damage, including without limitation to, any loss of profit, which may be suffered directly or indirectly from use of or reliance on such information. Scandinavian Capital Markets AB strongly encourages consultation with a licensed representative or financial advisor regarding any particular investment or use of any investment strategy.