aThe purpose of our curriculum is to help you become a consistently successful trader by employing a consistent trading process. This effort is complicated by the random and uncontrollable nature of the market and the unique mixture of natural human biases afflicting each trader. Everybody wants to capture profits while avoiding losses…but this is just not possible.
We all experience losses because forecasts didn’t work out as expected. Yet there is another type of loss which is even more painful and yet completely avoidable…turning a profitable trade into a losing one.
Part of a consistent approach to the market is deciding which Natural Trading Style best fits your personality and risk profile. Then implementing that base winning percentage by dialing in the desired ratio of profit to loss relative to the entry.
Once a trader has entered a position and set their stop loss and profit taking targets, they might be tempted to let the trade unfold naturally. But this approach may result in a trade that was profitable at some point but not profitable enough to reach the profit target, turning into a loss as it falls back down and reaches the stop loss.
Before getting into more detail, it’s important to note that many behavioral finance studies have been done which show that the more a trade is watched, the more nervous the trader becomes. Nervous trades struggle to follow their rules…so work to implement this strategy without over-watching your positions.
There are two methods a trader may follow to reduce the risk of turning a profitable trade into a losing one.
First: enter the position and set profit and target taking orders as normal. Then watch the position closely for ten days. This time period will need to be adjust with certain asset classes or trading approaches. Once the stock has successfully appreciated through this period, reduce the monitoring time to less frequent intervals and change the stop loss order as required. This goal is to raise the stop loss order above the entry to avoid having a profitable trade turn into a losing one.
The key factor in this approach is patience. don’t raise the stop too quick or too far. Give the position room to run and avoid getting stopped out.
Another strategy a trader may choose to employ to avoid the initial risk of a price drop on a new position is scaling in.
Markets are random and despite best efforts, the price action of individual equites cannot be reliably predicted. This is especially true during periods of high market volatility or in asset class which are naturally more volatile. That said, traders can have success in all asset classes if they fully implement the ideas we each in our curriculum and have a consistent, measurable trading edge.
That said, another way to reduce risk while capturing profits is through a technique known as scaling in. Scaling in to a position is simply using only a portion of the initial allocation for that trade to get into the position.
Assume that the risk per trade rules a trader has limits the allocation into a position to $3,000. For purposes of this instruction, we’ll assume the trader decides to split this initial allocation into three different buys of $1,000 each.
The second and third tranches of capital would only be allocated into the position once the first $1,000 was profitable. This rule means that more money is spent on a profitable position increasing the opportunity while limiting the risk.
For purposes of this example, we’ll use the following assumptions:
Now assume the equity continues to rise to $1.32 and the trader decides to spend the remaining $1,000 to buy shares. In this case, the stop loss of the first and second buy-in is raised to $1.16 while the third buy-in also has a stop loss at $1.16.
The first position is now profitable and the second position has a stop loss at the breakeven price. The risk is the same but the opportunity has now tripled.
The profit target of the third entry is now the stop loss of the entire position. In this case, the profit target of the third entry is $0.48 higher than the entry price or $1.32 + $0.48 = $1.80 (risk 1 to make 3).
Note: A trader must decide for themselves if the desired stop loss gave enough room for the stock to run without getting stopped out early.