In the first part we discussed the risk we have on the market – our initial Stop Loss being hit.
I was lucky to have a natural fear of financial loss operating in me on a very deep level from the first days I started trading. Interestingly enough, because I was so cautious with any potential loss, I never let my trades show any substantial gain either. Any time the trade would go my way even slightly I would get nervous and was rarely able to resist taking the profit.
In one of the previous articles I illustrated a very common example, showing how the fear would cause us to look for any signs of the reversal on the market – anything that will allow us to justify taking the profit way before the target.
After we learn that the market will often disagree with our point of view we start accepting that sometimes it goes straight to our Stop Loss. Such situations are inevitable and happen to even the best traders. But what about these situations when everything seems to be going exactly according to our plan?
Managing the floating profit
When the trade is already showing profit many traders automatically identify with that profit subconsciously. They rationalize that the market already showed that they are right and this is their well earned money.
The market can easily reverse against our position, no matter how much profit we have in it.
There are a couple methods we can implement in order to deal with these situations. In this post we covered a couple important steps in order to decrease the risk and reduce the psychological weight of keeping the trades for a longer term:
- Enter the trade with a couple positions with the same SL but different targets. I like to set the first target at 3 times the amount of my SL.
- When the first target is hit and part of the trade is closed, move SL to breakeven. This will turn the trade into a risk free opportunity to follow the trend (in reality, there is still the risk of losing the floating profit which we can never exclude completely unless we close the trade, but the original risk of losing money is now removed).
- From this moment we need to keep reassessing the market and adjusting our SL higher as the market provides an opportunity to do so.
At this point it is extremely important to adapt a different way of thinking about your trade. Instead of looking at the paper profit, look at the amount of money you already accepted and at the value of your current Stop Loss. In other words, the current profit is not whatever is floating, but the amount you already taken plus/minus the amount that will be accepted when Stop Loss hit – not your Take Profit.
Aiming for big targets
When you have the conviction that the market has the potential of giving you 10 times the amount you risked, it is definitely worth it to let the trade go – after we’ve already taken the first profit and made the trade a risk free opportunity by adjusting stop loss to breakeven. Many times the market will not agree with our conviction and stop the trade, but with experience we can hopefully learn to read the market sentiment better and better. When having a longer term perspective (trading Daily and Weekly charts) I found it essential to understand the underlying fundamental reasons why the currency can appreciate or depreciate the way you expect it to.
I like to ask myself this question when I am hesitating whether to let the trade go or close it: “Based on where I can trail the SL in these conditions and where I have my long term target, would I enter the trade right now? Do I still have a good Reward to Risk ratio in this trade?”
In other words, I will first check where I can trail my SL based on the recent price action. After I trailed it, I look at the distance to my target and my SL. Would I place a trade at the current price with such SL and TP? Does it still meet my minimum Reward to Risk ratio criteria?
Let’s take a look at 2 different scenarios:
- There was a recent retracement to the trend we are in and we can trail our Stop Loss behind that retracement. After doing so, we have 100 pips distance to our Stop and still 400 pips to our long term target – a respectable 4:1 ratio that makes it worth it to stay with the trade.
- The price rushed to our target in an impulsive move, not reaching it by 50 pips. Our floating profit is 500 pips and our SL is set 300 pips lower relative to the current market price. Because the price spiked higher to our target so fast, the market does not show any techincally sound level where we can trail the SL to reduce our risk. If we were to place a trade at this level, we would have been risking 300 pips hoping to gain only 50 – a very bad 1:6 ratio to take. In this case it is a much better decision to close the trade in 500 pips profit, 50 pips before our target, than hoping to catch these final pips and risk giving away 300 pips of our paper money.
Finally, let’s take a look at a recent trade that I’ve been managing over the last 3 weeks. It happens to be a rare example of proper management throughout a couple retracements when I was certainly questioning whether to take the profit or let the trade go. In hindsight, scaling out of the trade in small parts as the market was making new highs, was crucial to lasting throughout the whole move to my original target – it allowed me to secure part of the profit and decrease the psychological burden of supporting the trade.