Manage The Trade Or It Will Manage You

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 

• risk defined 

• 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.

Happy Trading,