Avoid Freezing When Trades Turn On You

Last updated on March 24th, 2020

A trader inevitably will face situations where they’ve missed certain information or acted rashly and subsequently found themselves in losing trades that forces them to make difficult decisions.

This can happen for a variety of reasons – it can be through lack of preparation or concentration or through impulsive trading for example.

It’s also possible to end up in this kind of position because of a technical error such as clicking in the wrong place. And if you trade using automation, don’t think you’re immune either.

Any system is only as robust as its weakest link – i.e. the human.

 

An Uncomfortable Decision

Almost invariably with these types of trade, by the time that you realize you’re in one, the market will be trading way offside, making your decision a rather uncomfortable one.

I tend to think of this realization as a “sobering up” – not necessarily because you’ve lost control of your trading and finally realized the poor position you’re in, but often because the market has paused long enough for you to make a logic based assessment of it.

The trade is offside so either you’ll have to take what may well already be a significant loss or decide where you will get out in the knowledge that more capital will be on the line for a trade that currently isn’t working.

A Closer Look

Say you’ve taken a short swing trade in the YM (E-mini Dow) hoping for a substantial retracement of the recent move higher. So you get short – perhaps on the break of the balance low as you don’t want to miss out, or even at a higher price.

However, a break of the balance low is short-lived and buyers step back in to push prices higher and against you position.

At this point you’ve missed your stop and whilst you’re concerned about losing more money, you don’t want to get out before you’ve been proven wrong.

break of resistance trading
You went short on the support break but price is now rallying against you.

On closer inspection you realize that in fact the market is in a trend channel and the upper trend channel line has every chance of playing an important role in deciding whether the market pushes higher or a reversal happens and you get away with a poor trade not losing you money.

trend line channel trading
Will the market stop moving at the upper line of the trend channel?

 

The Available Options

Once you realize you’re in a difficult position, before you make your decision it’s really important to ask yourself whether your new found insight is based on emotion or logic before going any further.

It’s easy to find lines to draw on a chart if you’re trying to see them!

When deciding what you’re going to do I would stress that it really depends on the size of your account, the size of the position and the size of your strategy’s normal stop.

So you have two basic options.

The first and simplest is to just exit at market.

Although at first it might seem like a dumb idea to do this, there are certainly some benefits.

The line of thinking could be “well if it goes further I’ll just hit out at market” or if it’s pulling back a bit “I’ll run it back in my direction until it turns and then hit out”.

This is all very well and good if that’s what you actually do in reality.

But so often the markets prey on this type of emotional based reasoning with ambiguous exit plans.

Once the move resumes, if the trader doesn’t know exactly where they will exit they will find it hard to take the loss.

If it does run back in their direction, they could become so set on the idea of it coming all the way back that when it reverses again, they don’t get out.

The other very clear advantage of exiting as soon as realistically possible is that if there is any heightened volatility (and these trades often do coincide with heightened volatility), there will be the chance to participate in any further movement rather than clinging on to a losing trade.

So the first option is good if you feel like you might be emotionally attached to the trade and if you believe there will be some good movement to trade.

The second option – adapt your trade to the circumstances you find yourself in.

In this case the first question you should be asking yourself is how likely the market is to break significantly further and how likely/how far is it likely to come back if it does.

Unless you try to assess what the chances of a successful outcome for the trade are, at least to some degree, you’ll not be able to appropriately decide the risk that you’re willing to take. Once you’ve done this you have several options.

You can place a fixed stop either above the last swing high (at 15672 in the example above), you could have a fixed stop somewhere above the upper trend line, you could use a trailing stop of some kind to minimize any further move against the position or you could use a combination of these.

The trouble is that the upper channel line is far enough away to add a good bit more risk to your already offside trade.

This is where trading more than a single contract comes into play. By adjusting your position size, you can offset additional risk either completely or until the upper trend channel has been tested.

Lastly, you could choose to hedge your position with another product in order to lock risk down.

This is what actually happened in the Dow example:

resistance holding trade
Resistance tests and holds

 

Stick to Your Guns

The biggest issue is that whatever you end up deciding to do with this kind of trade, you must stick by your plan and act with zero hesitation.

Many times it’s really easy to let emotions take over and just freeze instead of acting. It’s at this stage that a big loss can turn into a bigger loss can turn into a month killer or worse.

Any single loss is just part of trading and should not be allowed to impact your account to such a great extent.

If you do find yourself in a trade that’s beyond your normal tolerance levels, you must assess the situation and act in such a way that strikes a balance between restricting further losses and giving yourself the opportunity to lessen the blow.

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