In this episode of 2Traders Podcast, Walter and Darren dig into the problem of controlling your trading losses and trade management. According to Darren, traders often fall prey to a common mindset flaw. Walter shares a few interesting concepts regarding trade exits.
Walter also shares different perspectives from different types of traders and how this can help you find the most suitable trading systems to fit your personality.
Download (Duration: 18:54 / 21.6 MB)
In this episode:
01:10 – first impression
03:13 – initially wide
05:24 – balance
07:11 – brilliant entry
10:05 – random, scattered shot
12:33 – hard to believe
14:08 – relieve pressure
16:45 – idea of fit
18:04 – quit fairly early
Walter: It’s something for people to think about that you really need to consider how your trading system is putting pressure on you and if it’s the wrong kind of pressure that you are not able to withstand, then something has got to give. You’re either going to give up on the system altogether or better off, modifying it to fit you, right?…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to the Two Traders Podcast. It’s Walter here. Hi, Darren.
Darren: Hi, Walter.
Walter: So, we’ve got this question here and this traders says that he can’t control his losses and he notices that sometimes if he waits 24 hours, he’ll have 10x the profit than he normally would.
I think this is two different questions but you could wrap them all up in one, couldn’t you? He says he can’t control his losses and if he waited another day, a lot of times he would have a lot more profit than he ended up with.
So, what is your first impression too when you hear that?
Darren: I think, basically, I mean they are the same question. I think when he say he can’t control his losses, it’s because he’s clearly closing his trades early. The old “cut your losses short, let your winners run.” There is actually some statistical evidence to back up that as being one of the or if not the main problem that traders face.
It just sounds like really he is pulling prey to a very common bias that human beings have got and that’s not accepting his losses and then, when he gets that rush from being in the profitable trade, he’s closing them early.
Walter: Yeah, there’s a couple of things that come to mind when I hear this. One is exactly what you’ve said which is if you have trades that are losers and you get out too quickly, that’s great because it reduces your average losers size but it’ll also drastically reduces your win rate.
So, we’ve both talked about having stops far away. You just don’t think there’s any chance that your stop will be hit and that will of course increase your win rate. Sometimes, I think traders especially if you’re trading with a broker who is a market maker and you’re trading the lower timeframes and you have these really tight stops, it’s really easy to get jiggled out of those and that can be really frustrating specially when you see your trade going to your favor.
I’m pretty a big fan of having a stop far away from, even on the one-hour chart, if I’m trading the one-hour chart — which I rarely do — I like having that stop really far away from the entry price just because I think that helps with your, obviously helps with your win rate but people will argue with your reward/risk ratio gets blown smithereens when you do that when you have these really wide stops. What are your thoughts on that because I know you trade with pretty wide stops too, right?
Darren: Yeah, but they are initially wide and my belief is strongly that it really is. I need two factors that are going to decide whether you’re profitable or not and it’s not the specific method you’re using and it’s the market condition and it’s how you manage your trades.
The problem with trade management I find is that, it needs to have some sort of flexibility in there. You could say, “Okay, a 3:1 risk/reward, that is best” and for a lot of time, it will be but market conditions change and you need to be flexible with that.
Sometimes you need to pick up that the market has flattened out a little bit and perhaps in those instances take your profits a bit earlier. It’s very difficult to wrap that around some very hard and fast rules as an element of feeling there.
That in itself, brings problems as well because, then you resort to saying “Okay, my exit is going to be discretionary” what happens then is you tend to fall into your biases. If like I said, the market is going to be a bit flat and you’re not making as much money, you’re going to lean towards taking profit too early and not letting anything run.
It’s a really difficult problem and I think sometimes, how you construct your strategy and where you have the discretion and how you use discretion can be a real problem. I listened to a podcast from a champion poker player the other day.
She was talking about gut-feel in poker and she was saying “The problem most people have with gut, they just decide that they’re going to go with their gut.” And, she says that when she uses her gut, she always balances that with some math and some signs.
When she gets the gut feeling that she should fold a hand, she then kind of works through the other details. I think she’s about learning that skill of being able to balance discretion and rules and being able to react to the market conditions.
It’s very difficult to do and most people give up when they get to that stage. It is like the key skill that all traders have got really, is that balance of rules and discipline and that little bit of feel and intuition they’re getting back from the market.
Walter: Right and so when you talk about this, you’re talking about this in the context of exit, like getting out of a trade or the entire management of a trade?
Darren: The entire management because moving your stops can be really effective tool as well. Like you say, if you like to give your trades a bit more of a chance to go that way then, you’re gonna go with a wider stop but then if you can move your stop and reduce your stop by half, when it’s going in your direction, that can be a really useful tool.
At the same time, if you’re doing it too quickly then, it’s going to cut off all your winners and it’s really no point having the wide stop in the first place. All the elements of management and you can’t really say that you just need to master one, you have to consider them all.
Walter: Yeah, I agree. I mean, with your approach to trading, what’s interesting is, you don’t put much emphasis on the entry which is almost completely contrarian. Almost everything you read about trading this time about how this is a great entry into futures, forex, stocks, whatever “this is the best entry” you hear a lot about that.
Actually, I just read a report from somebody who, they had this, what they consider to be this brilliant entry and they sent an army of EA traders to test the EA version of this brilliant entry. The results came in. Any ideas on what the results were?
Darren: I’d say probably 50-50.
Walter: Yeah, they said, there was no advantage in the entry. It was all about the exit and the management of a trade that decided whether or not the system is profitable. They firmly believe they had this brilliant entry.
That’s interesting but one of the things I think I find interesting about this question because he seems to imply the he has, it fits in nicely with what you’re talking about. It seems to imply that, it feels like, it’s almost like he’s out of control.
He cannot control his losses and he cannot control his profits. It just feels really out of control, that’s the sense that I get from the question and it seems like “Oh, if I’ve managed it better, I would’ve been stopped out. If I have managed the exit better I would’ve made more profit”.
Probably one of the most interesting concepts I’ve ever heard in terms of exiting a trade was from a trader I know who firmly believes in splitting your position into four. He says, so if you’re risking 2%, that’s a .5, right? First one has a 1:1 reward to risk ratio. Risking a 100 pips to make a 100 pips.
Second one is 2:1 so, he’s risking a 100 to make 200. The third one is a trailing exit so he can go as far as it wants or maybe not so far and the fourth is well, he’ll pyramid into it. He’ll add more positions as it gets closer to his 1:1 target and if it retraces and goes against him it’ll stop him out at a break even.
It’s just like a standard pyramid but the stops are moved quite tight so it doesn’t end up as a loser once you start adding positions. What’s interesting about this is, no matter what the trade does, in a sense, you should be happy.
As long as you’re right. I mean, if he gets stopped out you get stopped out. You lose out on all four positions but if it only goes a little way, then your first exit is okay because it’s going to hit the 1:1.
Your trailing exit too might make a little bit, who knows? Then if it goes 2:1, same thing. At least 3 of your positions are going to make money. Your trailers going to make money, your 1:1 and your 2:1.
Then, finally if it goes really really fast to your target then all four are going to make money. It almost takes the decision off of you, you know what I mean?
Walter: It removes the decision for you. Now, I like that. I really like that because I feel like, we as traders, we too often take responsibility for our results. When our result are really just a random, scattered shot, you’ll never know if that next trade is going to, like I took a trade right before I went to bed last night and I thought, “This could go 90 pips, I can wake up in the morning and everything is all tidied up and done”
Of course, I think it went 40 pips and then retrace 20. It wasn’t as nice as I would’ve hoped but you just never know. You just never know and I feel like this trader is feeling like he should have control over his trading.
Maybe there’s more that he can do to let go, I don’t know. That might mean doing something like the way that you don’t put a lot of emphasis on the entry. You just take every entry that can be a good result and then everything is on the exit.
What I am saying is, maybe you can even reduce a bit of that decision making off the exit decision where you actually use some sort of method where you’re applying the shock in approach no matter what the trade does.
If it goes really far or just a little bit or whatever, some of the positions is going to be cashed out, if that makes any sense.
Darren: Yeah. I really like that line of thinking, Walter. I’m a strong believer in the strategy is not just about what is the best strategy that makes the most money. It’s about how you interact with that strategy, it’s going to decide long term and how much money you make.
The sorts of pressures that particular strategy are going to put on you in your decision making. So, you might sort of backtest a strategy that has really great result but when you come to execute it, it puts pressures on you at the wrong time that the important decisions are really difficult ones to make and then you make mistakes in the execution.
It’s quite interesting, going back to what you were saying about his answer. It’s like he knows what the data is saying. The data is telling him that all he needs to do is hold his trades longer and he’s going to make more money.
But, I imagine somewhere in his strategy, it’s giving him too much discretion on the exit so he’s basically going with his gut more than the data and the data is there right in front of him.
He can see it but he’s finding it hard to believe in that. He probably just needs to tweak his strategy and how he manages his trades to just ease that pressure where he’s clearly making a repetitive mistake.
Walter: Yeah, exactly. I think you’re spot on and part of it is just becoming aware of the fact that how you interact with your system is really the key here. That is a great point.
When you said that, it reminded me of — we had a webinar during the London open yesterday with a trader. He’s a scalper, he’s really good and he’s been doing it for a long time but when you hear him talk about it, it’s almost like he admits that there is no way that he is a type of trader that would feel comfortable holding a trade open and so he’s comes to grip with that and that is basically why he is a scalper. Because, he knows that he can’t deal with having an open trade .
He knows that, to him, the most important thing is to get out of that risky environment as soon as possible s when he gets out at 3 pips, he’s happy. In fact, I watched that happen twice during the webinar.
Twice during the session he had a really small profit, I don’t know 2 to 4 pips or something like that. Almost immediately after he closed it, the market would go another 2, 3, 4 or 5 or 6 pips but he was fine with that because he’s come to the grips with what was important to him and how he could relieve, like you say, relieve pressure from his trading.
The way that he relieve pressure is by getting out of that risky environment, which for him being a trader is a risky thing. He just wants to get out as quickly as possible. He does it on another side too when he took a loser. We watched him and he had a 15 pips stop and people are sitting there going, “You’re taking 3 pip, 4 pip profit and you have a 15 pips stop, how is this possible?”
But, we watched him on the loser and he got out at 5 pips. That is the way that he approaches it and I really think that what you said about being aware of how your trading system puts pressure on you is exactly why he trades the way he does.
I know the reasons why I trade the way I trade too but it’s something for people to think about, that you really need to consider how your trading system is putting pressure on you. If it’s the wrong kind of pressure that you are not able to withstand then, something has got to give.
You’re either going to give up the system altogether or better off, modifying it to fit you. I mean, that’s basically what you’re saying, I guess.
Darren: Sure, yeah. If your data is performing better than you’re performing trading the system live then, the problem is with you. You need to notice that, you need to be aware of it and then, you can tweak the system to help you deal with that. Help you deal with the recurring mistake you are making.
This is not unique or unusual. I’ve read some broker data recently about — the title of it was Why Most Traders lose. I know that it’s been a lot but this is one into a lot of data from a lot of brokers.
This was right at the top. It was right at the top that people generally don’t make enough on their winners and they lose too much on their losers. At the same time, you have traders like the scalper you’re talking about. He make a very small amount on their winners and have much bigger losers.
It’s really difficult to find out balance. I think you need to play with stuff a long time and you need to find out exactly where you are going wrong and address those issues.
Walter: Yeah, I think that is the critical piece. I know we keep coming back to this idea of fit. Fit between you, your personality and your beliefs and your system. The other important point that you just brought up is you can have a perfectly matched system.
It fits your personality and you can backtest the crap out of it, you know it is going to work. If it does not line up with your live trading results when you go live then, now you need to shift your focus to you because there’s something, probably most likely, outside of broker’s shenanigans is probably you.
That scenario that I think, for most traders, they only become aware of that once they’ve been around the block a few times that it’s possible that I can have something in me that’s kind of babbling up and changing my results.
I don’t know. I mean, it’s one of those things that you don’t… When someone is new to trading, they don’t talk a whole lot about trading psychology. They spend a lot of time talking about, “So and so makes x amount doing this and that and I am just going to do what he does”.
Darren: Definitely. I think that that was another bit of data that was in this report, was that out of traders that were successful, they’ve been around a lot longer time and you can find that most traders who never became profitable, they quit fairly early.
When I’m talking about a lot of time, I think it was more than 5 years for the traders that were consistently successful. It takes a lot longer than we hope it’s going to take. A lot of people quit before they get there.
Walter: Hopefully, that’s helpful for this trader. I appreciate your time, Darren. I am looking forward to next time when we talk about the frustrations of being on the wrong side of the market. So, that will be interesting.
Darren: Cool, Walter. Great to catch up!
Walter: Alright. See you soon. Bye!