CUTTING LOSERS SHORT ~ forex trading jobs new york
Any Forex traders seeking general advice about how to make money out of the Forex market will by now have heard “cut your losing trades short”, “cut your losses”, “limit your risk” several times. What do these clichés actually mean, and are they important? If so, why?
BASIC FOREX MONEY MANAGEMENT
Let’s start with the basics. The whole object of trading is to take a chunk of money and grow it into a bigger chunk of money. In trading, you are essentially taking a series of bets, some of which will win some of which will lose. If you have a streak of losers, the value of your chunk of money will shrink. It is important that this shrinkage does not get out of control for one often-overlooked reason: if your chunk of money is halved in value, you have to double it just to get back to where you started. So, the more you lose, the proportionately greater your winnings have to be. Therefore when you plan your trading strategies, it is important to define a worst-case scenario and make sure that you limit your risk per trade so that your account does not draw-down beyond an amount which you have already determined will be acceptable to you.
WHERE TO PUT YOUR STOP LOSSES
The deeper and more detailed meaning relates to placement of stop losses, whether these are hard stop losses or soft ones. It is in the nature of the Forex market that the best trades usually take off in the desired direction right away and very quickly, spending little time underwater. For this reason, trading strategies aiming for high relative rewards in the winning trades generally perform better with tight stop losses. Many traders think that a stop loss should be placed at the price where you would feel “wrong” about the trade. This is incorrect thinking: a stop loss should be placed where it is likely to give you an optimal reward to risk ratio, bearing in mind how many consecutive losing trades you are prepared to suffer. For example, a strategy with a stop loss of 5 pips might be more profitable in the long run than if a stop loss of 15 pips is applied, but this is likely to produce greater losing streaks, and the impact that will have on account balance has to be taken into account. In short, the money management strategy used becomes integral to the logic of the stop loss.
DON’T DOUBLE DOWN!
Another important principle that lies behind the cliché is the tendency of traders to “double down” i.e. “revenge trade” after a loser. Even worse is the practice of using “mental” soft stops and letting them drag on as they fall further into the red. As a basic rule of self-preservation, do yourself a favour and never, ever widen a stop loss, and always use a hard stop loss until you have profitable for several years – and only then when your typical risk per trade is very small compared to the size of your account.
HOW TO COPE WITH STOP LOSSES
Being stopped out can be psychologically hard to cope with, especially when the trade then turns around and travels in the originally desired direction just a pip or two after hitting your stop. A psychological tactic that can make this more tolerable is to remember that although that stop meant you lost money, probabilistically it stopped you losing even more money. Take a look at a trade you were stopped out of that went on to travel hundreds or thousands of pips against you, and remember how much money that stop loss saved you.
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