The Fractal Futures Trader » daytrading

Day Trading: Knowing When to Exit a Losing Trade

trader7757 — Sat, 01 Jan 2011 19:36:38 +0000

I am guilty of it; you are guilty of it; the very best traders are guilty of it-sometimes it is very difficult to know when to fold. There are a plethora of explanations to the irrational desire to hang on to a losing position in the misguided hope that your trade is going to make a dramatic turnaround. It rarely happens, and most traders end up riding the trade too long and smashing into their stop loss. The loss is always painful, and most of us (if we can be honest with ourselves) can usually identify a point in the trade where we should have exited with a minor loss. Yet, we often fail to take advantage of this early exit and incur a substantial loss.

Why?

A great deal time and research have been spent on trading, especially the emotional and psychological aspects in trading decisions. As a group, people have a strong need, and desire, to be right; and in the opposite sense, people have a strong aversion to being wrong. Bailing out of a potentially disastrous trade is an admission that you, as a trader, have made a bad trading decision. In short, you were wrong. No one wants to be wrong. To be sure, I don’t want to be wrong. Yet, as day traders there is usually a point in a trade were we would be well advised to admit we are wrong and save a bundle of money. Most day traders seldom avail themselves of the early exit option.

When a trade is obviously going the wrong way it would seem obvious that a wise trader would be anxious to minimize his or her loses. I have looked at some of my worst trades and been able to accurately pinpoint several exit points that were obvious. Unfortunately, hindsight is 20/20. Our emotions control much of our thinking in relation to trading, and once I (or any other trader) is convinced the trade is a good one it is no small task to change your mind quickly and accept that the trade is a terrible one. As I said earlier, we like to be right; we dislike being wrong, and admitting we are wrong on the selection of a trade often leads to disastrous results.

Many texts and noted authors claim that leaving your emotions on the sideline is absolutely essential for successful trading. I don’t know about you, but my emotions are an integral part of my personality and the notion that I can carte blanch abandon them is wishful thinking, at best. On the other hand, I do think we, as traders, can learn to minimize our emotions in the trade selection and trade management process.

What is the secret? There is no secret; but developing the ability to see things as they are rather than as we hope is a skill to be developed. The market is an emotionless, mechanical device and does not take your emotions into consideration in its day to day operations. What we, as traders, think is completely irrelevant. The skill that I work on constantly is seeing the market from a realistic point of view; not my point of view, but what is really going on in the market price action. Reality can be a very painful teacher, especially when you are on the wrong side of a trade. But it is reality that we have to work with, and traders must learn to trade from the perspective of what is really occurring in the market, not what we wish the market to do, or how we think the market should move.

In summary, I have noted that removing your emotions from trading is basically wishful thinking. On the other hand, we can learn to develop a realistic view of how the market is moving and trade accordingly. It’s no easy task, but with practice reality can become your primary viewpoint, not your wishes.

Related Blogs

YM E-Mini Stop Loss, Risk/Reward Ratios

trader7757 — Thu, 28 Oct 2010 02:18:52 +0000

You hear a lot of talk about risk/reward ratios in trading, and as an individual who enjoys math I find myself baffled at the methodology many employ to arrive at their risk/reward conclusions. For example, some traders firmly believe in keeping their stop loss and profit targets roughly equal. After all, they say, it is important to keep your risk on the upside the same as the risk on the downside. Is all risk the same?

For example, let’s assume an example where a trader establishes a 30 tick stop loss and a 20 tick profit target. Many would assume that this trader is letting his losses run and his or her profit targets stay finite. It’s an interesting argument, but I don’t necessarily agree with it.

Why?

Well, in this argument you have to assume that it is equi-probable that the market will rise or the market will fall. With so many variables under consideration, I don’t believe that the probability for an YM e-mini to rise or fall is equal. Further, what is the probability that the YM e-mini will rise 20 points versus it falling 30 points? In most trading situations, long or short, small measured moves in the market are far more likely than large sweeping moves. In short, the market is far more prone to equilibrium or movement contained to movement one or two standard deviations from the mean. Which is not to say that large moves in the market do not occur, they do. The important question to ask yourself is, how often does the market move in dramatic fashion versus how many times does the market move at a very measured pace?

This attitude allows trades to develop and gives a trader the time to allow them to develop. Further, because a trader sets his or her stops to 30 does not necessarily mean that he or she is required to allow the price action to plow into the stop loss. At any time during a trade it is the trader’s prerogative to shorten his or her stops. (As a quick aside, I would also point out that it is essential to only shorten your stops, it is never a good idea or sound trading practice to expand your stop loss). However, if the fundamentals of a trade change during the execution of the trade, there is no problem with making a hasty exit. It only makes sense to limit your losses, especially if the dynamics of your trade change.

In the last 10 years, it is far more likely for the market to move 10 points than 30 points. A quick back test of this assumption showed that 10 point moves are 32% more common than 30 point moves. Interesting. In this respect, it is difficult to apply traditional calculus probability theory to trading. In short, there is a dependent relationship, especially from a probability standpoint, in calculating the likelihood of a given market move; the market is far more likely to move in smaller moves than larger moves. This is an important concept to understand and can help a trader reassess his or her approach to managing risk. Standard understanding of binary outcomes in assessing risk do not necessarily apply in trading the YM e-mini.

As you might expect, I am a proponent of running wider stop losses than many. In doing this I allow my trade time to develop and understand that the variable most responsible for winning trades is time. You must allow yourself ample time for the trade to develop and running tight stop losses will generally deprive most traders of the time required to trade effectively. Market noise and related factors seem to knock many traders out of their trades before they can realize a profit.

In summary, I have made an argument for running longer stop losses and explaining my criteria for doing so. I base my beliefs on a simple maxim; the market is far more likely to move in small steps than it is in large steps. Further, I can employ this strategy in formulating my approach to trading and run the wider stops to let my trades develop. My enemy in trading is not the price action but the amount of time I give my trades to develop; if I limit my trading by employing tight stops I deprived myself of the time needed for the market move I expect. Market noise can knock me out of the trade prematurely and I will realize losses. I want time in my trading and I am willing to buy time by expanding my stop loss.

Related Blogs

Day Trading: High Probability versus Low Probability Trading

trader7757 — Sun, 12 Sep 2010 00:04:27 +0000

There is a natural desire, especially by beginning traders, to want to trade excessively. This is not difficult to understand. A day trader cannot make money unless he or she is in a trade; this is the general outlook of most novice day traders. But this line of thinking has some serious faults, and it is important to learn to select your trades in a systematic and emotion free state of mind.

Of course, selecting high-quality trades is easier said than done. At various times, very unproductive trades form set up patterns that can be very enticing. Low probability trades are like the lure of Medusa, they look great at first glance, but can cause serious losses if systematic analysis of the trade is not undertaken.

How do you know the difference between a high probability trade and a low probability trade?

First and foremost, every day trader must make an assessment of whether the trade is with the trend or against the trend. While many popular courses on trading tout the wisdom of trading retracements and identifying peaks and troughs in trading patterns, these are all unsound trading methodologies and I know of few successful day traders who employ them. Great traders are masters at taking what the market offers, and not trying to create trading opportunities themselves. A novice trader’s ability to effectively identify trending patterns is an essential skill because the very best traders trade primarily with the trend. In my view, less than 10% of your trades should be countertrend trades.

Secondly, many novice day traders and a plethora of trading systems rely heavily upon oscillators and indicators to choose potential trades. On the other hand, most seasoned day traders pay close attention to actual price action when trading. Important principles like support and resistance are prime movers in determining whether a trade has real potential. For example, taking a short trade into a known support is the recipe for a losing trade. Obviously, a successful day trader must have the ability and experience to identify known areas of support and resistance to avoid taking trades into these hazardous trading zones. Most experienced traders can spot support and resistance by glancing at a chart; this skill is learned through observing thousands of charts throughout trader’s career. Of course, there are add-on programs to most charting platforms that can spot support and resistance for a day trader who has not acquired the ability to identify support and resistance on his or her own. For some, these add-on programs can be very effective and helpful. In any event, any trade that will lead a trader prematurely into known support or resistance is often a trade that is doomed to failure and it’s important to realize these trades are very low probability in nature. In short, price action is where the real trade selection takes place, and indicators and oscillators supply filtering information to reinforce the strength or weakness of the trade under consideration.

This is among the most difficult concepts to learn in day trading, as many day traders are looking for a magic oscillator or indicator that will revolutionize their trading results. I am sorry to report that, to date, no such magical oscillator or indicator exists. Look to identify solid trades in the price action of any chart, and then calculate the potential to profit by identifying where support and resistance will affect the performance of your trade. Many traders use pivots and other predictive indicators to calculate support and resistance. For many years, I was in this camp. As I have grown older, I prefer to identify support and resistance as it develops on the chart, not through some artificial predictive means. This attitude is subjective in nature, and his a choice each individual trader has to make.

In summary, we have looked at trading against the trend and concluded that countertrend trading results in low probability trades, on the other hand trading with the trend results in higher probability trades. We have also noted that known support and resistance are prime movers in determining the feasibility and potential profitability of any trade. Price action is the name of the game, and learning to read and interpret what price action is telling a day trader is the real secret to trading success. If you can master reading price action, it is highly likely you can become a successful day trader.

Related Blogs

How Do I Start to Day Trade E-Mini Contracts?

trader7757 — Mon, 16 Aug 2010 06:57:12 +0000

Learning to day trade e-mini contracts has become one of the hottest professions on the Internet. Unfortunately, many people enter the e-mini day trading arena with little or no experience and are disappointed in the resulting lack of success. I need to point out that e-mini day trading is a learned skill and not an innate ability. So it is important to engage in some preparation before attempting to day trade e-mini contracts.

First and foremost, a new e-mini day trader should research and choose a quality day trading system. This is not necessarily an easy job, because there are a wide range of trading systems and some are priced exorbitantly high. Spending time on some of the trading chat boards and asking questions about the quality of various trading systems is a great way to get some feedback on which course is considered successful. Even then, you may need to examine each recommended course and interview the owner of the course. Some great questions to ask might be:

1. What are the owners credentials and trading experience that qualify him or her to advise others on trading methodology?

2. What is the overall success rate for past students of his or her of course?

3. What is the cost of the course and are there ongoing charges to remain an active member?

4. Does the course require the student to purchase proprietary software to trade with the particular system being sold?

5. How long does it take from the start of the course until a trader can safely trade e-mini contracts?

While some trading educators debate the use of demo accounts, I highly recommend them. The problem most people have with e-mini day trading demo accounts is that they tend to not follow the trading system they have learned. They tend to over trade or experiment with ideas they have that are not based upon sound methodology. This can lead to bad habits which may carry over to trading with real money. The answer to this problem is a simple one; you must trade your demo account exactly as you trade your live account, that is, the account you plan to trade with real money.

Sound methodology and a good deal of successful practice time on a demo account is an excellent way to prepare a potential e-mini day trader to trade successfully and profitably. It is important to have a plan before you begin to trade. As I said at the beginning of this article, day trading e-mini contracts without any preparation will generally lead to failure and loss of your capital.

Related Blogs

Beginning Traders Can Learn to Day Trade Effectively

trader7757 — Mon, 28 Jun 2010 14:53:22 +0000

There is a general feeling among experienced day traders that beginning traders cannot trade profitably for several years. As a trading educator, however, I have found that properly trained beginning day traders can trade effectively from the start. However, the trader must be motivated and well versed in the material presented, and have the self discipline to adhere to the parameters of the trading system being taught. This is, of course, no small task. Just the same, the financial rewards far outweigh the time and effort expended to develop the skills necessary to trade.

In my program, The E-mini Trading Professor System, we have found that beginning day traders can be a profitable within several months of starting our system. It is important that the trader sticks with the rigid guidelines established for proper trade setups and maintain that discipline throughout the course of an average trading session.

Once a beginning trader learns to day trade only with the trend, which is one of the most important aspects of our trading system, trade selection becomes very far easier process than trying countertrend trading techniques. Learning to trade with the trend is no small feat, either. There are many countertrend trades that, at first glance, appear enticing and a sure bet to earn money. Unfortunately, countertrend trades are generally just retracements in a broader trend and must be avoided in order for the beginning trader to profit.

Much of what we teach in day trading centers around the psychological/emotional approach that is necessary to trade successfully. Many trading educators do not devote much time or effort in stressing the importance of psychological/emotional considerations. We consider these issues to be among the most important and toughest skills to master in the day trading process and devote several modules in the course that consider psychological/emotional considerations at length. If you can control your mind, you can control your day trading and make sound, rational decisions about selecting the proper trade set up.

While every day trader may not be ready at two months to trade profitably, many are. It’s important to understand that every beginning day trader assimilates information at a different rate and in a different manner. That being said, some traders are ready to trade earlier than others. On the other hand, I have not found a correlation between how soon a trader is ready to trade and the ultimate success they achieve. Simply said, some traders are ready to trade earlier than others, but once the trading methodology is assimilated there is no appreciable difference in the actual performance. I encourage beginning day traders to take their time and learn the information at a rate they are comfortable. This approach assures the proper retention of the information.

Bottom line; beginning traders can trade profitably sooner than it was once thought. I say this was one caveat though, the traders who have learned the information and practice the most on a demo account are the ones who enjoy the greatest success. Jumping into trading a live account with real money involved is not encouraged; on the contrary, it is far preferable to hone the beginning trader’s skills on a demo account so that they understand, in a real sense, the material presented in the course and can apply it.

Related Blogs

Day Trading: Are You Giving the Euro and Forex Your Attention

trader7757 — Sat, 26 Jun 2010 17:48:57 +0000

I am not a huge Forex trader, though I occasionally dabble with day trading Forex. With the problems Europe is having, which have greatly affected the euro and have taken on some added significance and are certainly worthy of keeping an eye on. While many people are loathe to admit it, the fate of the euro is directly related to the performance of the US dollar. So I have day traded some Forex lately, even and even more often day trade the futures currencies of several European countries, along with the euro.

The video today is an excellent overview of the euro and some of the effects it will have in the future on our economy. There is also discussion concerning the future of the European Union and how it will affect us here in the United States. While talking about the global economy is a very unpopular subject in some circles, there is no doubt that the global economy is a reality and we are a distinct part of the global economy. So, I hope you enjoy the video and glean some important information while watching.

Click here to watch the Forex video and the discussion of the euro

Related Blogs

Day Trading: Market Convergence and Divergence

trader7757 — Sat, 26 Jun 2010 04:26:47 +0000

Most of my day trading involves, either directly or indirectly, the principles of convergence and divergence. For day trading in the futures market, I am concerned primarily with converging indicators and agreement and oscillators. But there is a wide range applications for the principles of convergence and divergence. I thought this video from INO was very informative and will provide you with some valuable insight into the practical application of bearish and bullish convergence and divergence.

While the indicators used in the video are not necessarily the ones I incorporate in my day trading course, it is not difficult to see the practical applications of the principles being demonstrated. In my opinion, you will find this video informative and fairly helpful.

I encourage you to have a look at this video and see if it might be of some value in your own personal trading.

Click here to watch this great video on Convergence and Divergence

Related Blogs

Is E-Mini Day Trading a Risky Proposition

trader7757 — Wed, 05 May 2010 19:29:47 +0000

There is a general perception that day trading futures contracts is a highly risky business and not for the faint of heart. Day trading can be a very risky business, especially when traders use poor money management techniques, faulty trading technique, and improper risk assessment for trades. For the uninitiated, day trading is a great way to lose a nice chunk of money.

It doesn’t have to be that way, though. Far too many traders charge into the markets and improperly prepared for the challenges they will face. It’s easy to understand why. A casual examination of a future chart shows a serpentine pattern, up and down, that ought to be fairly simple to trade. There is also a tendency to assume that the serpentine patterns follow some sort of organized pattern. Figure out the pattern, and you ought to make money.

Wrong!

Study after study has shown there is a high component of randomness to futures trading charts. I do think there are some identifiable patterns buried in the random patterns, but they are not as obvious as one might think. No, learning to trade is far more than a perfunctory glance at a chart and placing trades when you think the market is moving one way or the other.

The very essence of trading is containment of risk. There are many components traders utilize to minimize risk, and most center on the concept of probability. The idea is to take high probability trades, and pass on low probability trades. Through training and experience traders learn the characteristics of high probability trades as well as the characteristics of low probability trades. Further, careful management of your futures trading account is essential. In order to minimize risk, a trader should never trade more than 8 to 10% of his account on any given trade.

But there is even more. I get ample opportunities to watch traders practicing and am amazed at how many traders enter trades without stops. It is essential to determine your level of risk on a given trade and set an appropriate stop loss order to assure you do not lose an excessive amount of money on a trade gone badly. In my opinion, this is the most frequently violated risk management tool. Frankly, it baffles me.

Day trading is far from living on the edge. The goal of the day trader is to both profit and minimize risk. Obviously more risk increases the likelihood of losing trades, and losing trades are not what traders want. For that reason we employ a variety of risk reduction procedures to increase our likelihood of success.

The more adept a trader adapts risk management techniques, the more prosperous he will be in the long run. Risk containment should be the primary goal of every trader, and lack of proper risk containment is the number one cause of trader failure. While it is very romantic to think of day trading in the same light as being a gunslinger, just the opposite is true. A good trader avoids confrontation with excessive risk and cowers against low probability trades.