Online Trading Academy Article of the Week
by Rick Wright, Online Trading Academy
Hello traders! A couple of weeks ago I had the good fortune to be teaching at our Long Island, New York office. At one of the lunch breaks during class, a student of mine from a previous class wanted to stop by and say hello, and ask a few questions about why she isn’t as successful as she thinks she should be.
Believe it or not, we instructors do like to continue to help our students! Hanging out in class with you for a week or so is fun, but we absolutely want to continue to help after class. Usually a new student will get help from their online classroom, the Extended Learning Track, or any one of our other resources available. But this student made a special trip to the classroom, so I was glad to help out.
This student, let’s call her Jennifer, had one large trading problem, and a couple of small problems. The large problem in her trading wasn’t that she didn’t have a trading plan (which is the problem most new traders have,) it was that her rules for trade management were lacking. In the Online Trading Academy classes that I teach, I recommend to new traders to go for at least a 3:1 reward to risk ratio. If you are trying to make $300 on this trade, you should be willing to risk $100 to achieve that goal. Sounds simple enough, right? However there is a wrinkle to this plan. Many traders will have rules for how to manage trades once they have been entered. For example, moving your stop loss to break even when the trade is in the money the amount of your stop is a rule some traders use. How does this affect your realized reward to risk ratio? Having an expectation of 3:1 is fine, but how did your trades actually work out? Did you move your stop loss the wrong way when price approached it? That is a trading mistake, don’t do that! Will you move your profit target further out as price approaches it? This is something I personally do, letting my trades run as far as possible.
The problem Jennifer was having wasn’t identifying good 3:1 reward to risk ratio trades, it was that her realized gains were only about .5, while her losses were allowed to hit her stop loss every time. She said to me
“I get more nervous when I have green on the screen (profits) than when a trade is going against me.”
Obviously she is nervous about losing the small gains, and the first hint of a profitable trade turning against her made her close out the trade. In the following AUDJPY chart, a very easy 3:1 trade presented itself – trading with the trend, buying a pullback to demand; even a trendline intersection showed up! Trades don’t get much more obvious than this. Notice the blue shaded circle, and the shape of the wick on the red bodied candle. That brief bit of selling pressure that caused that wick may have shaken some of you out of a well-planned long trade. What would your realized gain have been? Only about a one to one reward to risk.
There are several ways to help combat this issue. The first way was mentioned earlier in this newsletter. Another is managing a trade that is going your direction, locking in profits as the trade progresses. There are several ways to do this, including using a technical stop, a moving average, or even a trailing stop. Each has its own merits. I prefer a technical or manual trailing stop. This is where I move the stop to just below a previous demand level for long trades, and above previous supply in short trades. Using this technique, your realized gains can sometimes be much larger than just a planned 3:1.
Yet another way to keep you from taking yourself out too early in a trade is to stop watching your trades. Have you ever had a boss that watched you like a hawk, a micromanager if you will? No one likes a boss who does this, and your trades don’t like it either! If you stare at your trades for every minute, any small pullback might be an excuse to get out of the trade. If your levels are good and you are trading with the trend, micromanaging your trades will probably be detrimental to your realized gains.
Another issue Jennifer had was her position sizing. In the beginning of your trading career I recommend trading extremely small size, a mini lot or two. Even micros if your account warrants it. Eventually you should be risking ½% of your account on a trade, building up to 2 or even 3 percent when you have a lot of experience under your belt. Jennifer was already trading 2% risk per trade, even though her track record wasn’t consistent enough to warrant that higher level. Start small, and when you get good at trading, you will still have money to trade! Start big, and by the time you get good you may have blown up an account or two! There are lots of good demo traders in the world, because they don’t have real money to trade with anymore.
The last issue I’ll discuss is Jennifer’s activity level. In day trading, there are usually 3-5 good setups a day per symbol. Sometimes the number is zero, sometimes higher than 5, but watching the charts for hours should give you several chances to make some pips. Jennifer’s activity was over 5 trades every day. As a trader and especially an instructor, I must let you know that we don’t get paid on the quantity of trades we make, but of the quality. I am constantly looking for reasons to not take trades at certain levels. This is backwards from most new traders! Most look to trade any level or any reason that they can find on the charts. I would rather take fewer, better trades, than lots of average trades that won’t make me any more money.
So there you have it! How not to be a great forex trader is to take too many trades, micromanage every wiggle on the chart, and to quickly take profits and let your losses be large. If you want to be a great trader, find the highest quality levels, let time and the charts work for you, let your winners run and take small losses! Sounds simple enough!