There are literally thousands of different trading strategies and systems that a person can utilize to trade stocks. Many of them may put you in a position to be a profitable trader…if you have the discipline to stick to your game plan and not get emotional about a trade. The market has an uncanny knack for seemingly knowing the amount of pain and monetary losses a person can withstand. No sooner than a trader sells a losing position they’ve been holding for hours then within 5 minutes the stock reverses course and would have been a winning trade. It can seem as if the market knows you exited the position and now feels the need to not only take your money, but also give you a swift kick in the ass as it heads in the direction you expected based on your analysis.
Cutting losses and having the ability to move on is one of the more difficult aspects of trading. Successful traders understand how to manage losing positions and re-evaluate to determine their next potential profitable trade. Below are a just a few of the mistake’s traders make with positions against them.
- Not defining the risk parameter prior to entering a trade. Trading is all about risk and reward. A good trader understands what the potential profit might be based on his analysis. But even more important is what is the risk. Traders need to determine the amount they are willing to lose BEFORE entering a trade. Some traders use mental stops where they have a price in mind that they plan to exit the position. Will the trader be disciplined enough to actually exit at that mental stop price? An undisciplined trader may convince them self to give it a little bit further and hope that the stock reverses in their direction…but unfortunately that’s not likely. And that trade against you can snowball from a small loss to a big one before you know it. For that reason, many traders place a stop-loss order to liquidate the position when the stock hits a certain price against them. Good traders set stops for a reason…to limit losses and move on to another trade idea.
- Adding to a losing position or “average down”. Averaging down is something that can sound good in theory but often results in a bigger losing trade than a trader initially was willing to make. Averaging down basically means adding to a position that is already against a trader. For example, if a trader originally purchased 100 shares of a stock for $50 per share and later the share price dropped to $40 per share, 100 more shares could be purchased reducing the trader’s cost basis to $45 per share. Now the stock is $45, and the trader would only need a $5 price increase to get back to even. Again, sounds good in theory. Traders often stay in losing positions for two reasons. One, they believe they are right and two, they don’t want to lose money. The problem with this is that the market has already told them they are on the wrong side of the initial trade and trends tend to stay in place. Unless there is a fundamental or technical change, the odds of adding to a loser and making it a winner are not good and will regularly lead to larger losses.
- Turning a day trade into a swing trade or long-term investment. Traders need to have defined goals when entering a position. While there can be many factors included in this, for now I’m referring more to the timeline of the trade. Based on a day trader’s research and analysis, they enter a trade with a certain expectation for a favorable move in their direction within a certain time frame. If you entered a position based on a that timeline and it’s against you, it can be a difficult decision to close out the position prior to the end of trading. I’ve seen many day traders justify taking a position that’s against them overnight because they claim they believe in the company or they like it longer term anyway. While that may be true, that’s not the reason they entered the position and the trade was not based on those claims. It’s best to keep day trades as day trades and not convince yourself otherwise when the position is against you.
To become a consistently successful trader involves several factors, one of which is having the discipline to accept a losing trade. Being able to admit you’re wrong and take a loss is a difficult prospect for many. Unfortunately, losses are a part of the game and it comes down to how you handle it and what you can learn from them. Getting out of a losing position when you’re supposed to will allow you to think more clearly and identify the next trading opportunity.