Off to Vegas, L.A., to New York...
You should assess the potential reward against the definite risk. If you have definite profit targets, you can calculate your risk/reward. Your potential reward is the distance from your entry to the 1st profit target and your definite risk is the distance from your entry to your initial protective stop. You can decide if it is above a certain minimum. This is serious because your win/loss ratio is almost certain to fall below 50/50 over time, such that you have more losing trades than winning trades, ask the da boyz about win/loss. You then need to be taking steps to ensure that your winners are making you at least 2x your money risked on those trades compared with your losers, which are losing you 1x your money risked. This also means the size of your winners is directly related to the size of your losers. Again, this is vital otherwise you have no way of knowing how many consecutive losses you can fund from a previous winner. A string of losses is inevitable. As leading trader educator Van Tharp of the Van Tharp Institute (http://www.iitm.com) says, losses as large as 20% don't require that much larger of a corresponding gain to get back to even. But a 40% draw-down requires a 66.7% gain to break-even
Money management, which is position-sizing or bet-sizing, is absolutely essential. Again, as Van Tharp says, poor position sizing is the reason behind almost every instance of account blowouts.. by having defined entry and stop triggers for trades based on the extremes of signal/reversal bars. Consider a long trade set-up with a 2x minimum potential risk/reward, using the standard fixed fraction position sizing, you have a ready method to decide how many shares, contracts or lots to actually trade. Divide a fixed % risk of your account - say 2% if trading leveraged instruments such as futures or forex or 0.5% for unleveraged equities
For example, say you are risking 2% of a US$20,000 account on each trade. That means $400 per trade. If your trade set-up is on, for example, a E-mini S&P 500 futures contract, with an entry price of 1400 and initial protective stop of 1398... your initial risk of loss is 2 full pts x $50 per point = $100. $400 / $100 = 4 contracts can be traded. Simple, but yet important
Run the winners, cut the losers. This is exactly what almost all amateur traders have real problems doing. The answer is to have a method of forcing you to stay with your winning trades as long as logically possible, with cutting your losing trades at a pre-defined price. If you are trading off a simple ABC correction on your chart, profit targets can be determined based on the length of the correction and the length of the prior trend that it may be correcting. Targets for the trend, if it resumes, to aim for. If you are only taking trades with a minimum potential risk/reward of 2x to start with, then you can use the profit targets to take profits on your trades - because you know they are at least 2x risk/reward
Another, you may rightly use the 1st profit target to determine whether your minimum risk/reward outlook is 2x, however choose to trail, say, a volatility stop as your exit strategy. Welles Wilder's Average True Range has been developed into just such a trailing stop. Adjusting continuously for price volatility and often keeping profitable trades open for longer. As long as such a plan is inscribed in your trading plan and not used on an emotional whim, that is OK. Again, to quote Van Tharp, trading and investing are very simple processes and we human beings try to make it into something much more complex. Keep it simple |
