Last week we discussed two scenarios with equal losses and gains which still cause different experiences. Now, we move on with the two main goals you should keep in mind to keep the amount you lose in trades small.
The biggest part of keeping losses small is to avoid losing trades entirely, which is not easy to do. Here are some tips to help you prevent losses.
Look at fundamentals that might affect the asset before you trade it. Perhaps there was an oil spill that is likely to push up prices due to a reduction in supply. If you know this, you can immediately write off trading against this news
Study the charts before entering a trade. Being tuned in to the movements of the price as well as the recent and long term support and resistance levels is important. It allows you to place trades that make use of these levels, and avoid trades that ignore the rebounds/breakthroughs they might cause.
Avoid highly unclear situations. The market is never crystal clear, that is for sure. However, if you are looking at many indicators and they do not agree, it might not be a good time for you to trade. Why enter a trade you are unsure about? There are many good opportunities that will show themselves clearly to you, wait for those times.
Take a break. When you are not doing well, it is time to admit that to yourself and stop it. Some days you will not be doing your best, and trying to force profits back into your account through revenge trading is an awful idea. Take some time, reflect on mistakes, relax and get ready for the next day.
Be patient. If you realize you may have missed out on a good opportunity, do not jump on it at the last moment. This is like trying to jump onto a moving train, and is called ‘fear of missing out’. If you’ve missed out, you are better off thinking about how you could have gotten into the trade on time next time.
Have a good plan. Know when you will get in and get out of trades. If you have prepared when to enter and exit, you will limit the chance of getting into a bad trade. This could include knowing what you will do if a profitable trade is starting to drop. It is tempting to stay in the trade and hope your larger profits return, though it may be safer to take the assured profit.
This is the sidekick to preventing losses. As Benjamin Franklin said: an ounce of prevention is worth a pound of cure. He was apparently talking about fire safety, but it goes just as well here. You don’t have to fix bad trades that you have avoided. That said, it is unrealistic to think you won’t get into bad trades. Here are some ways to limit the losses you have.
Stop loss orders. If there was a famous poster to promote limiting losses in trading, it would be a picture of a stop loss order. These are the safety nets of trading. Traders often have hope that their losing trade will turn around, but this can lead to account balances being wiped away. Stop losses keep you from keeping in a bad plan. Yes you may have turned around some of the trades that hit the stop loss. There are often going to be greater numbers of trades that keep going against you, and some of these will be huge losses. Stop losses keep you from wiping accounts as well as give you back your capital and margin space to seek the next good trade. Even if you were able to turn around a bad trade instead of using a stop loss, it may take awhile. You often could have made more money taking your loss quickly and entering other profitable trades. It is also a good way to manage risk overall by using a good risk/reward ratio in how you set stop loss and take profit orders.
Go against your plan when proven wrong. Imagine you enter a trade because the price is approaching a range that you think is a solid support level. If you see the price move through the support and prove you wrong, it is usually prudent to close the trade before it gets any worse. A plan is only useful while its reasoning is sound and valid. Don’t be afraid to admit you are wrong, and enjoy the satisfaction of being right when you correctly exit the ill-conceived trade.
Control your emotions. This idea flows through much of this article. Even if you are trying to control your emotions, it is often easier said than done. This means that some of the times you will realize your emotions are out of control, you will already be in a trade. This is a good time to consider closing your positions that are losing, and gather yourself. This piece of advice counts for being tilted by trading itself or being tilted by unexpected life events. Practice with emotional control, such as a few minutes of meditating before trading.
Be at your best. It might sound painfully obvious, but trading when you are not at your best is a really bad idea. As much as possible you want to be well fed, hydrated, and well rested. If you realize you are not those things or are sick or hungover, think about stopping your trading.
Choose position sizes that manage risk. If your whole account balance is on the line repeatedly, there will be a point when you wipe the balance to zero. Instead, limit your trades to a small percentage of your balance, such as 1% to 3% of your balance risked in a single trade. This allows your skill at trading to shine over time, and recover from any losses. It also naturally makes trading more exciting as you profit, since your position sizes will keep growing.
There are many things we went over in this article. The overall advice can be summed up in these points:
Be aware of how the market and asset are behaving. Be aware of your own strengths and weaknesses. Be fully prepared for each trade.
Be patient and controlled. Have a plan and adapt it as you need. Pause yourself when things aren’t going well. Trade by the book: use stop losses.
Admit your mistakes as quickly as possible. Then reflect on them and most of all learn from them. Use the insights to adjust your future trades towards less/smaller losses.