Tuesday, June 5, 2012
Letting a winner turn into a loser
Greed, fear and hope are the terrible curses that afflict traders. Hope can be eliminated with clear fixed stops. Greed and fear need to be balanced against each other and will never really go away.
Not every trade will be a winner and for a lot of traders, taking a first profit greatly improves their equity curve. This is especially true for reversals and attempted breakouts out of a trading range since these setups fail routinely.
For example, traders expecting an imminent reversal of the trading range (since b38 was a 2L LH after a trendline break -- a major reversal setup) will often hold all-in and will refuse to take a profit. Such traders may even keep their stop above the signal bar until an additional LH is formed. Those traders would have lost today. A trader that took an early profit on the other hand, was a small winner even though both were wrong about the overall market direction.
If a trader sold b38, he is best served by taking a profit when he is right and moving the stop to breakeven when his target is filled. If the market moves against him twice, i.e., ticks beyond a bar twice against his trade (above b48), he would need to exit if he has not been filled. If he was filled, he should move his stop to breakeven on the balance of his position.
A trader who sold b23 today as the first pullback after a W made a profit of 4 pts. He should keep his stop on any runners at breakeven. Keeping the stop above the signal bar or worse, above a prior swing is a symptom of hope and not objectivity. No matter how obvious the reversal at b12 and the first LH at b23 may look, the trade can always fail and its best to let it stop you out and look for a fresh trade.
Even in a very strong high momentum trend, you are usually better off taking an early profit. This is because if you entered early in the move, the chances of a sustained trend are unknown and if you enter late, the chances of a trend reversing or going into a deep pullback stopping you out are always existing risk factors.