Books keep telling me to limit my losses to 1-5% of my account… so that means I’d have to be pretty right about my position… but when I was using demo, the position was falling 80 pips negative… but it eventially turned around and made me over 300 pips… if I stuck to the rules and kept it only at 50 pips, I would have been stopped out, lost 50 pips and lost the opportunity to make the 300+ pips… thoughts?
Here’s a portion of a post from several years ago which addresses how to determine your SL,
how to determine your TP, and how to evaluate your Risk/Reward ratio –
Have you ever done this?
You study your charts, and find a situation that catches your eye. You really like the way things are shaping up for this pair. You conclude that this pair is poised to move higher, and you want to get on board.
You open a LONG position, and immediately set a stop-loss to protect yourself. Your stop-loss is 30 pips, because that’s about as much pain as you can stand.
You definitely want this trade to justify the risk you are taking, and you have heard the advice of the “experts” to use a R:R ratio of at least 1½:1, so you decide to set your TP at 2R — that is, 60 pips.
Now, you sit and wait. Price moves up and down, up and down, up and down, all the while trending higher toward your TP, and you’re feeling hopeful.
At about +30 pips, price stalls and begins to retrace a bit. You start to sweat, but you hang in there, because you’ve always heard, “Cut your losses, and let your profits run.” You don’t have a loss; you have a small profit. So — determined to let it run — you hang in there. And sweat.
There are lots of scenarios that could unfold from this point forward. Obviously, the desired scenario is this one: the retracement ends, price resumes its upward move, and your TP is hit. But, you’re telling us that it almost never works out this way for you.
So, let’s analyze this trade from a different perspective.
There are two horrendous mistakes in the way this trade was structured.
• The first involved the STOP-LOSS. Placing a SL at your pain-threshold is about the weakest thing you can do. Probable support levels should have dictated where you placed your SL. Support comes in many forms: previous daily, weekly, and monthly lows (or highs); pivot levels; fibonacci levels; and even trendlines (which are potential dynamic support or resistance levels).
If your chart suggests a logical place for your SL, and it’s more than you can tolerate, then either (1) cut your position size in order to make your risk in dollar-terms acceptable, or (2) this trade is just not for you — wait for a better one.
• The second horrendous mistake in the trade described above involved the TAKE-PROFIT. Placing a TP at a point that will make you a certain desired profit is as bad as placing a SL at your pain-threshold. But, that’s exactly what you did in the trade described above: you arbitrarily decreed that price should rise 60 pips, because 60 pips is how much you wanted to earn.
Probable resistance levels should have dictated where you placed your TP. Better yet, two or more probable resistance levels should have dictated two or more TP-points; in other words, if possible, you should have scaled out of your position in a way that covered your risk as quickly as possible, while still allowing the remaining portion of your position to run further into profit.
Suppose you do all this analysis, and determine that probable support and resistance levels are offering you a trade with only R:R = 1:1? If R:R = 1:1 is unacceptable to you, then this is a no-brainer — you don’t take this trade.
When you open a chart, you are viewing a battlefield. Before you wade into that battle, let the strategic and tactical situation on the battlefield (not your pain-threshold) define the risks. And let the strategic and tactical situation on the battlefield (not your greed, or your fixation on a R:R ratio) define reasonable potential profit objectives.
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A good outcome to one trade is useful experience but it doesn’t prove anything.
Even in this example its quite possible you could have used your SL at -50, and then re-entered at -80, to make a basic net gain of 330 pips, better than your basic 300. But likewise price could easily have gone to -180 then -280 then -380 and pretty soon you’re wiped out by one bad trade.
When you get long in a trade its because price is probably going to rise. If price goes to a level (higher or lower) at which it is probably going to fall or probably not going to rise any time soon, why would you stay in it?
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First determine the direction, you have to determine whether to go short or only above a certain price, and then find your own buy or sell trading signals. Wait patiently for it to appear.
This is called a rule in China.
Sometimes it is much better to determine stop loss not depending form possible (or affordable) loss, but on current market situation.
For example:
- define price level, when the trade becomes wrong.
- calculate distanse between entry price and that level
- use the result and pre-defined risk amount to calculate position size.
Using such approach you will have similar risk-reward ratio and right risk in every position.
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