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Cutting Losses
What elements of the trading game do you concentrate on each
market day? Do you push hard for the big gain but face big
losses when the action suddenly turns on you? Or do you slowly
build up each profit and always watch defensively for a quick
exit when wrong? The path you take will define your success or
failure as a trader.
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Our online trading course MASTERING THE TRADE uses the
simplified table just below to illustrate a few important
observations about profit and loss. Most trading strategies have
a built-in success/failure rate. For example, scalping incurs a
high %WIN but a low AvgWIN. Alternatively, buying breakouts
reflects a lower percentage of winners but the average gain is
greater. Regardless of how you trade, the market offers only
three ways to improve profitability (for any given number of
trades):
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| Day traders have fewer profitability options than position
traders. Price tends to move away from an entry point as a
function of time. So individual day trading gains (AvgWIN) are
generally smaller than position trading gains. Very short-term
time frames also frustrate attempts to raise %WIN since day
traders must be right immediately while a position trader can
wade through many whipsaws to get to a profit.
- Raise your %WIN
- Raise your AvgWIN
- Lower your AvgLOSS
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But day traders are in a much better position to control losses
than position traders. The price-time tendency now works to
their advantage. In other words, incurred losses should be
smaller (on average) because the position is held a shorter
period of time. This allows day traders to take their individual
losses closer to -0- than position traders.
Manage the loss side of trades and you'll increase profits more
quickly than chasing gains. In preparing your exit, recall a
valuable rule for optimal technical analysis entry: execute your
trade where price must move only a short distance to prove that
you are wrong. This frequently defines a strategy where you
enter a promising position right at support/resistance. If price
goes through the line, exit immediately with a small loss and
get on to the next trade.
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| You have to be very, very
good before you allow yourself to be bad. %WIN simply
measures your winners against losers. If you make money
on 3 out of 4 trades, your %WIN is 75%. See how the
average loss changes from the 75% to 25% levels. |
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| AMZN's daily range expands
over a 3-day holding period. This tendency of price to
move away from an entry point underscores a natural
advantage the day trader has over the position trader or
investor. The shorter a position is held, the more
efficiently losses can be taken. Day traders must
capitalize on this mechanism through quick exits on
non-performing entries. |
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