Category: Risk Management

First, You Must Learn How Not To Lose

I read a tweet somewhere which I thought was really good, but I can’t remember the exact wording right now.

It goes something like this (I’m paraphrasing):

“In order to make money from trading, first you have to learn how not to lose money.”

Really good advice.

This is what I’m currently still working on – minimizing my losses.

It’s frustrating when I make good trades here and there, but then give the gains away soon after by entering silly trades which I shouldn’t have taken.

Things I’ve Learnt About Trading

  1. Don’t chase after trades. Let the market come to you. Take what the market gives you, at the market’s own timing. The more you try to chase after wins, the more losses you will get.
  2. Be contented with the profits that you managed to get. Resist the temptation to think about what you could have made, and just focus on the profits you actually made. It’s always better to be in the green than in the red.
  3. Whether you win or lose, just stay the course and stick to your strategy. Switching strategies only makes things worse. (This is assuming your strategy is a sound one and has been fully tested.)
  4. Don’t feel happy when you win a trade, and don’t feel disappointed when you lose a trade. In fact, just don’t feel anything. Be emotionless, as if you were a bot.
  5. Trading is a long-term game. You are merely doing your best to ensure that the odds will work out in your favour in the long run.
  6. Even the world’s best traders suffer losses. Nobody can consistently buy at the lowest and sell at the highest.
  7. Don’t focus on the profits. But rather, focus primarily on flawless execution of your entire strategy. The profits will then take care of themselves.
  8. If your strategy doesn’t have specific rules for (a) entry criteria, (b) stop-loss, (c) take-profit, then you don’t have a complete strategy.
  9. Your strategy rules must be so clearly defined that if you were to let someone else read your strategy rules, he/she would be able to make the exact same trades and get the exact same results as you would.
  10. A mental stop-loss is probably not a good idea.
  11. Trading against the trend is usually not a good idea.
  12. Win-rate means nothing if you’re just scalping for very small profits each time. But it sure feels good to see a high win-rate.
  13. If you only strictly risk 1% per trade, then the good news is that the most you could ever lose in a trade, no matter what happens to the market, is only just 1%. This is a very comforting thing to know.
  14. When you hit a string of losses, you will be glad your bet sizes were kept small.
  15. Everybody’s character is different, and thus every trader will have a specific strategy which will suit him/her. Find the strategy that suits you best. Just because another trader uses that strategy, it doesn’t mean that strategy will necessarily suit your style and temperament.
  16. Nobody ever made money having a great entry into a trade. You only make money when you exit a trade. Your exit strategy is far more important than your entry.
  17. There is no perfect way to take profits. Every take-profit strategy will have its own pros and cons. No take-profit strategy can capture all the available profits all the time. Just find the one that gives you the greatest peace.
  18. Risk management is what keeps you in the game. Revenge trading only hastens the blowing up of your account.
  19. Never give yourself targets, e.g. “I’ll close this trade once this trade hits $300 profit.” or “I’ll take all my profits from this trade once my account balance hits $12,000. I just want my account balance to hit $12,000 before I’m done for today.” The market doesn’t care about your targets.
  20. Approach every trade the same way, regardless of your account balance. Execute every trade the way your strategy dictates. Take profit exactly the way your strategy dictates. Don’t take profits early/late just because your account balance is high/low.
  21. There isn’t a single trader out there who has never wished he/she could have done things differently. Every trader makes mistakes: Jumping into sub-optimum setups, moving to breakeven too early, taking profits too early, fiddling with stop-losses, risking too much per trade. We’ve all been there. It’s how you deal with the mistakes that sets you apart.
  22. And most importantly – React, don’t predict. Take what the market gives you. Never expect anything from the market. The market doesn’t owe you anything.

Why A Big Position Size Is Detrimental

You’ve probably heard it a million times by now that you should only risk 1% or less on every forex trade you make.

Some might say “Sure, but if your strategy is a winning strategy anyway, what difference does it make to risk 1% or 5%? Your win-rate still remains the same.”

That is true to some extent.

But there are a few disadvantages to using a larger position size as compared to a small one.

The most obvious one, of course, is that by using 1% you can survive a longer string of losses. If you’re risking 5% per trade, you’d be in dire straits if you hit say 10 to 12 losses in a row.

If you’re risking 1% per trade, even if you lose 12 trades in a row you’re still left with 88% of your account intact.

If you’re risking 5% per trade, when you lose 12 trades in a row you’re now left with only 40% of your account.

Additionally, a larger bet size tends to bring about the following “mistakes”:

  1. Makes you feel too emotionally invested in the trade since the stakes are higher (i.e. you’d feel much more pain if you lose the trade).
  2. Makes you set a smaller-than-intended take-profit target because you want to cash out the profits as soon as possible before the trade goes south. (For example if your strategy is meant to take profits at 2x, you may set only 1x for this particular trade because the stakes are too high.)
  3. Makes you cash out the trade too soon because you are simply too anxious about the trade. (For example, if your intended risk-to-reward ratio was 1:2, you may decide to just cash out at 1.75x profit because you’re not prepared to wait for price to hit 2x and you’re too fearful of the trade going south.)
  4. Makes you increase your stop-loss if the trade starts to threaten your stop-loss level, because you simply can’t bear to get stopped out on such a big trade.

The four mistakes above can easily screw up what is supposed to be a profitable and sound trading strategy, because you start to go off-script by cutting corners and short-changing your projected profits, and it will cause you to be far less profitable than initially expected.

And for all the reasons listed above, I feel that all trades should always be 1% or less.

Trust me, I’ve done the whole “large position size” thing many times, and it almost always never works out, and that’s why I speak from experience.

The Art of Taking Partial Profits

Pursuant to my last post below on exit strategies, I stumbled on this YouTube video which I thought was rather insightful.

For some reason, very few people discuss the finer details of exit strategies, e.g. setting multiple take-profit targets, taking partial profits, moving stop-losses to breakeven, letting trades run etc.

Most people seem to only focus on ideal trade entry conditions.

Hence, I found this video really insightful because he actually shows some calculations on the different partial take-profit scenarios, such as what happens if your first take-profit is 50%/60%/70%/80%/90% of your position, and what the eventual overall net profit from those different trades will be.

Very useful to know.

But ultimately I’m just glad to see that there is at least someone on YouTube who is highly interested in going much deeper into the finer mechanics of trade exit strategies, because I myself had also been spending the past few weeks thinking hard about this subject.

Of course, in an exercise like this there will always have to be certain assumptions that you are maintaining a fixed win-rate (say 40%) and risk-reward ratio (say 1:3).

Personally, at this point in time, I’m beginning to lean more towards the following trade management rules for my own style of trading:

Take-Profit 1: Take 50% profits at 1.0x risk, and move stop-loss to breakeven.

Take-Profit 2: Take the remaining 50% profits at 2.0x risk.

Assume my position size (or risk) is $100, and assume no commissions in this case:

If price moves to my first TP target (i.e. 1.0x risk), then my minimum profit for this trade would be $50.

That means that even in the worst possible scenario thereafter, I will not make any less than $50 on the trade since it has already been cashed out (and because I had also moved my stop-loss to breakeven at the first TP target).

If price moves to my second TP target (i.e. 2.0x risk), then I would have made my maximum possible profit for this trade, which is $150 in total (i.e. $50 at first TP, $100 at second TP).

And yeah, these numbers feel quite right for me.

What’s Your Exit Strategy?

The are tons of YouTube videos about the best entry signals for day trading.

However, I feel there is a relative lack of discussion with regards to exit signals.

Which is ironic, because someone once said that the exit strategy is far more important than the entry strategy, and I think that is absolutely true.

You don’t make a single cent from an entry strategy. The exit strategy is where your money is made.

Every exit strategy has its own pros and cons.

Let me try to summarize:

EXIT STRATEGY 1: “SET AND FORGET”

Description: Set a fixed stop-loss (e.g. 1x ATR) and take-profit target (e.g. 2x ATR) and don’t do anything else.

Pros:

  • Easy to manage. In fact, no management required at all.
  • Won’t get stopped-out prematurely (as compared to moving up your stop-loss midway through the trade).

Cons:

  • Potentially frustrating if price comes very close to hitting your profit-target but then it goes all the way down and you end up losing the trade instead.
  • Determining the optimum take-profit target is tricky. Is it 1.5x? Or 2x? Or 2.5x? A lot of backtesting is required to determine this.

EXIT STRATEGY 2: USING EXIT INDICATORS

Description: There are numerous indicators which can be used as an exit indicator, such as moving average lines, MACD, Parabolic SAR, Heikin Ashi bars, SSL Hybrid, Aroon, etc.

Pros:

  • Straightforward. No ambiguity.
  • Occasionally you may catch really huge moves.

Cons:

  • In my experience, you usually leave significant profits on the table, which can be frustrating. For example, your trade may have gone to 4x profit, but the exit indicator only gives the signal when it comes back down to 2x profit. Also, if the move is a small one, you may actually end up with no profit or even a small loss. Some people may not be able to take this.

EXIT STRATEGY 3: USING A TRAILING STOP-LOSS

Description: This method means you don’t set a profit-target at all. You just let the trailing stop-loss trail price all the way until it comes back down and triggers the trailing stop-loss.

Pros:

  • Easy to implement. No management required. Just let the trailing stop-loss do all the work for you.
  • You may catch really big moves.

Cons:

  • Determining the optimum trailing stop-loss value is a tricky problem. Too big, and you may end up with no profits if the move is a small one. Too small, and the trailing stop-loss may get triggered easily.
  • Similarly with using exit indicators, you may end up with no profit or even a small loss if the move is a small one.

EXIT STRATEGY 4: TAKING PARTIAL PROFITS

Description: Take off partial profits in tiers when price reaches specific checkpoints, e.g. cash out 25% when it hits 1x profit, cash out 25% when it hits 1.5x profit, and cash out all the remainder when it hits 2x profit.

Pros:

  • You are wisely putting some money in your pocket as your trade becomes more and more profitable.
  • Psychologically comforting. You know that even if the trade suddenly goes south, you already have some profits safely cashed out. You will be more willing to let the trade run until it hits your desired take-profit target.

Cons:

  • Tedious to manage, especially if you have multiple trades going on simultaneously.
  • You will collect less profits as compared to if you had waited till the final take-profit target to cash out 100%. For example, if you had a profit-target of 2x, you will collect more profits by cashing out 100% of your position at 2x, as compared to taking partial profits along the way.

Apart from the 4 strategies above, you could even do a hybrid strategy where you take partial profits in tiers, and then let the remainder trail with either an exit indicator or a trailing stop-loss.

I’ve spent countless hours pondering over what the best exit strategy for a trade is.

And the conclusion I’ve reached is that there is no one perfect exit strategy.

It depends on factors such as your personality, the style of trading you prefer, your risk appetite, the volatility and nature of the instrument you trade, etc.

If you’re the kind that likes to make your profits slowly, surely and steadily, then maybe Exit Strategy 4 might be best suited for you.

Personally, I don’t really like Exit Strategy 2 and 3 because I just don’t like seeing that I’ve only made 1x profit on a trade that had gone as high as 3x at one point. It just doesn’t sit well with me.

As such, at this point in my trading, and after trying out so many different types of exit strategies, I’m leaning towards Exit Strategy 1 (“Set and Forget”) because despite its simplicity, I actually find it’s one of the most suitable methods for me.

But of course, before you decide to adopt any kind of exit strategy, make sure you do a lot of backtesting first.

Why A Small Position Size Is So Important

Trust me, I’ve made every mistake that can be made when it comes to forex day trading.

I’m starting to learn one thing – the key to success is to use a small position size for every trade (typically 1% of your account).

You won’t believe how hard it is to adhere to this 1% rule.

Sometimes you see a great setup, or you “feel good” about the trade, and you want to risk more than 1%.

Sometimes you get into a string of losses, and you want to risk say 5%-10% on a single trade so that you can quickly get back to breakeven for the day/week.

Don’t do it. Just don’t.

It usually will not end well.

Apart from the fact that a 1% position size helps you protect your capital when you face a string of consecutive losses (i.e. you cannot possibly lose more than 1% per losing trade), I feel the most important aspect of the 1% rule is the mental part of it.

By risking only 1%, you are much less likely to get too emotionally invested in that one trade.

It’s just 1% of your account. The stakes are considered very low.

If you lose it, it’s still fine. It’s not the end of the world. You’ll live.

You will be able to confidently let the trade play out and not do the following things:

  • Moving your stop-loss to breakeven too soon. (In fact, with a 1% position size you could even afford to not move your stop-loss to breakeven and let the full trade play out, which might even be more profitable in the long run.)
  • Taking your profits too early, before your trade even hits your intended profit target. (How many times have you decided to cash out the entire trade early because you felt the stakes were getting too high?)

Moreover, the best thing about the 1% position size is that you can simply “set and forget” – just set your desired stop-loss and take-profit, and walk away from your computer and let the trades play out naturally.

You don’t have to worry about managing multiple trades (assuming you’re juggling multiple trades simultaneously) by constantly moving stop-losses and taking partial or full profits.

You don’t have to watch every second of the trade play out and agonize over every tick movement.

In other words, once you’ve set the trade parameters, you just simply don’t have to care.

Trust me, it’s far less stressful and taxing this way.

But to each their own.

Professional Loss Taker

I like this term a lot – “Professional Loss Taker”.

I feel it’s a great mindset to have when trading, because you will have to deal with losses whether you like it or not.

If you simply cannot stand losing trades, then perhaps you shouldn’t be trading.

Trading Should Be Boring

I recently saw this, and I love this quote so much.

It’s so true. You really need to get to the point where trading becomes boring.

You need to be completely emotion-less and not care less whether you won or lost your last trade, knowing that you have a system that will give you an overall nett profit provided you stick to it completely, and trade often enough.

Once you reach the stage where winning or losing each trade means nothing to you, you know you are on the right track.

Trading should be the complete opposite of a roller-coaster ride.

A Great Way To Manage Risk

Came across this tweet which I thought was really good.

To rephrase it, there are basically 5 outcomes to any trade:

  1. Big win
  2. Small win
  3. Breakeven
  4. Small loss
  5. Big loss

By setting a stop-loss, you effectively eliminate number 5 (i.e. big loss).

Isn’t that great?

You have effectively eliminated the WORST possible outcome of the 5 possible outcomes of a trade.

If this isn’t reason enough to adhere religiously to your stop-losses, I don’t know what is.

Don’t Be Harlan

I don’t play poker and I know very little about the game, but I nonetheless enjoyed the movie Molly’s Game, directed by Aaron Sorkin and starring Jessica Chastain.

The scene which hit me the most was the one above about the poker player Harlan.

It’s almost scary, because of how real it is.

This is a cautionary tale which anyone who day trades should know about.

Harlan “played tight”, and by that I’m assuming it means he was a very careful player.

He was shrewd and gave very little away. According to Molly, Harlan was “playing poker while the others were gambling”.

Harlan was the type of player you hated to play against because you had nothing on him.

But watch what happens to Harlan in the scene above.

He was doing really well that night, but a strange and unexpected loss causes him to snap, and he then starts to degenerate into a revenge gambler.

He started trying to “swing for a home run on every hand”.

He ended up losing BIG. Really BIG.

And that eventually ruined his marriage and his life.

Harlan kept borrowing more and more money, and his famous last words to Molly were “I just got to get back to even”.

I say this scene is really scary because it is so real.

It’s no different from what happens in day trading. Anyone who has tried day trading will understand what Harlan went through.

Revenge trading? Been there, done that.

Telling myself I want to just get back to even? Yup, done that many times as well.

That is why trading discipline and money/risk management is so important.

I’ve learnt things the hard way, and I suspect it’s the same for many other day traders as well.

Always have a stop-loss.

Always only risk a small percentage of your account per trade.

Never take a big risk on any single trade.

Don’t average down when you’re losing.

Don’t swing for the fences.

Don’t let losses get to your head. Once you’re on a losing streak, just walk away.

And lastly, don’t be Harlan.