We’ve spent a lot of effort now perfecting a trading system. The system we have designed is the best system I know of for minimizing your risk and making consistent high returns. We will continue to discuss where we can make improvements, since trading is all about improving, but I wanted to touch on the psychology of trading for a moment as this will have a huge impact on results.
The systems we have discussed are designed to take greed and fear out of your trading as much as possible. Decisions of when to put a trade on and when to take profit off or exit the trade at a small loss are already made for you before you enter the first trade of the week. All you need is the discipline to follow the rules to make a nice steady profit. Money management is built in so you automatically cut your losses short and maximize your gains. Unfortunately, greed and fear are part of being human and they can never be eliminated completely. If left unchecked they will destroy your trading career. At this point, greed and fear are the biggest threats to your success.
You can put too tight a stop on and get quickly stopped out in a volatile market and it will not affect your career, or conversely run too wide a stop and give up a few more pips on a stop out than you needed to. That problem can be worked and optimized by using the tools we have discussed, but taking small manageable losses on the chin, as Indy said in his trading plan, is an important part of successful trading. Whether you give up 5 pips too many or don’t squeeze that extra 5 pips of profit from a particular trade will not affect your career over the long run. What will destroy your career is fear and greed, so we need to address that specific issue now.
Since fear and greed can never be totally eradicated from the human mind, your trading system must be designed to combat this twin headed monster. If you haven’t had to fight this battle yet, your time is coming and the battle will be intense. The last thing you want to happen is to have to make decisions about how to fight the good fight while you are in a trade. Choose your field of battle to give yourself the best chance of victory. All those decisions should be made ahead of time when you have nothing at risk and encoded as rules in your system. I’ll give you a quick list of money management rules that should be encoded in your trading plan as a defense in the beginning, but we will need to improve upon this list as our plans evolve. I hope to get questions and have a lively discussion on this topic moving forward.
The total risk to your trading capital can be defined as the position size times the stop loss value of your trades. Risk per trade should be limited to 1% of trading capital per trade. Some times I will have four or five pairs trading at the same time, so I allow 2% maximum risk to my trading capital total at any time. If I want to put more trades on, I either have to close one, or wait until one of the existing trades go into profit before putting another on.
The other factor in risk to trading capital is your stop loss value. We’ve had a lot of discussion about stop loss settings, but it’s important that you have a very mechanical method of setting stop losses so your trading is consistent. The two rules to do battle with the twin headed monster here is to always trade with a stop loss and never ever move a stop loss against the direction of your trade for any reason. Let it stop out if you must, but exiting a bad trade early is even better. Even if you exit 1 pip before hitting your stop loss on a bad trade, you are building a wall of disciplined defense that will serve you well in the future. If you are running 4 lots and are able to exit a trade gone bad 5 pips before it hits your stop loss, you have just made an extra 20 pips on that trade. That’s good defense and good trading. It doesn’t matter after the fact if price goes up or down. About half the time it will do one and about half the time it will do the other. But good trading is always good, no mater the price movement after the fact.
[B]The bottom line is, you must learn to trade without ever moving your stops against the direction of your trade for any reason. You must implement this rule if you are going to be successful in this business.[/B] Of course, once the trade is in profit, you can add some percent of your increasing profit to your stops to keep riding the trend, but only as your profit is increasing. If your profit is decreasing, that is the trade is approaching your stops, you are NEVER allowed to increase your stop width to stay in the trade. This is a primary line of defense and you must have the discipline to hold this line no matter what.
In the beginning you will be stopped out of some really good trades early and that will hurt. This is the pain we must all go through to be successful in this business. This happens to me even now after decades of trading. You will learn over time how to adjust your stops to minimize risk to your capital and maximize your profit potential. For now, just implement the rule that you will never ever move a stop against the direction of your trade this battle will already be won.
When you are winning greed dominates, and when you are losing fear dominates. Greed will cause you to take more risk than the you ever intended to for the trade. Fear will cause you to stay in trades you should get out of, fearing taking a loss, and it will cause you to take profits early when you should let them run because of fear of losing them back. To win the battle against this two headed monster, you must make all the decisions in advance before you are in the trade and you must be honest with yourself. You must review your trades after they are closed and look for any hint that fear or greed affected your decisions. In case one or the other did affect your decision, you must design rules that will prevent that from ever happening again. That’s pretty easy to do and I or someone here will help if you need it. The never ending battle will be to have the discipline to follow the rules you set. You must be very demanding of yourself in this regard and accept nothing less than 100% compliance with your own rules. It won’t start out that way, but having a written plan helps and it gets easier over time.
Happy Trading
