Thursday, June 7, 2012
Reversing your postion on a loss
One of the prevalent causes of overtrading is reversing every time a trader gets stopped out. Many traders fall into this trap because they only pay attention to bars and have no choice but to flip on anything that may look like a reversal bar. For example, if a trader shorted b29 as two legs up in a bear and then on b32 he may interpret that the trend may have flipped and buys b32 and then sells b34 and so on.
The second reason traders fall for this is that have heard that a failure is a strong signal and a failed failure is an even stronger signal and two failures in the same direction are extremely strong etc. Therefore if a trader sold b34 as a W24,29,34 he may see b37 as two pushes down and reverse to long. The chop in this area may end up being read as fL2 or fH2 or any number of things causing him to interpret a new direction with every bar.
The real problem here is that the trader is focusing on a micro level. A trader always needs to keep in mind if the market is trending (b1-b17) or chopping around (b25-b45), breaking out and failing (b46-53) or breaking out and continuing (b56-70). Being aware of the nine transitions reduces directional error.
Reversing very often is rooted in the fear of missing an impending very large move. This symptom also suggests that a trader's sense of market direction is undeveloped. This can be combated by realizing that if you are stopped out twice near the same price area, you are probably in chop and your entry is effectively trying to predict a breakout. Predicting breakouts is one of the hardest things to do in trading, whereas waiting for a breakout to occur and jumping on the first pullback is far easier.
My way of avoiding falling into this trap is to assume that if my trade fails, the market probably in a chop and except in the first hour, I will avoid re-entering until the price moves away from the area. For example, if I read b34 as a W and sold it, I will not trade until price moves away from b34, i.e. until b49.
There are two exceptions to this rule. If an opposing trade fails twice, I may consider entering again in the same direction. For example, I was stopped out of my trade on b17 long, b20 setup a short and failed twice when b25 triggered. This should only be done if you are expecting a very large move.
In the first hour if the stop out was due to a fixed stop and not a theoretical stop, I will usually re-enter. For example, if I shorted b1 and my 6t stop was taken out, then the trade hasn't theoretically failed until b2 high is taken out. I will enter on b6 even though the price hasn't moved away from my losing trade.
Remember that there are one or two and occasionally three good swings a day. Focus on capturing a decent portion of those. This ensures a very high risk to reward ratio and eventually a very high win to loss ratio.