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Don’t Hold Your Breath Too Long While Under Water

The headline of this educational feature pertains not to swimming but to trading. Most professional traders do not hold onto their losing positions for very long. Once a trading position goes “under water” most professional traders will immediately begin looking for an exit strategy­-if they do not already have one in place (and most do) via protective stops.

I had lunch with my trading mentor the other day and he shared a very good story with me. It went something like this: There once was a trader whose trading decisions were based upon using a “plumb-bob.” (For those who have never worked on a construction site or in the land-surveying business, a plumb-bob is a turnip-shaped weight that is attached to a string to help determine if a structure is straight.) When this trader dangled the plumb-bob and it swung back and forth from north to south, he would buy. If the trader dangled the plumb-bob and it swung back and forth from east to west, he would sell. The trader had success using this methodology–with one simple rule applied: At the end of the first day, if his position was “under water,” he exited his trade first thing the next trading day.

The moral of the story is: Traders can (and do) have all kinds of trading strategies, but prudent money management is paramount. In other words, cut losses short!

Over the years I have received emails and telephone calls from traders who were way “under water” and had not prudently liquidated their losing trading positions. These traders were “hoping” the markets would turn around and losses would be reversed. Any time a trader has losses which are so big that “hope” comes into play, it’s usually a situation where prudent money management has not been employed.

It’s also important to mention that traders who know they have waited way too long to exit a losing position should not think already-big losses can’t get even bigger–much bigger. I’ve heard many traders say, “Well, I’ve lost so much already that now I might as well wait for the market to turn around because it can’t go much farther against me.” That’s a recipe for disaster and potential financial ruin. This is where the saying, “Never meet a margin call” comes into play. If a trader gets a margin call from his or her broker, it’s best just to close out the losing position and look for trading opportunities in other markets.

I’ve often mentioned the old trading adage: “A market will do anything and everything possible to frustrate the largest amount of traders.” Guess who are the traders that get most frustrated? It’s the ones who are hanging on to losing trading positions, waiting and hoping for the market to turn around so they can get their money back. “I just want to get back to even” is a desperate quote that comes from some traders who are under water. That “hope” is usually never realized.

One of the most interesting aspects of trading futures is that there are a few basic and effective rules that have been used by successful traders for years. However, adhering to these rules on a continual basis can be most difficult for many traders–including the experienced veterans. Why is this? It is because some of the most effective rules in futures trading go against the grain of human nature. Indeed, the “psychology of trading” plays such an important role in trading success.

The article is written by our old partner Jim Wyckoff at TradingEducation.com

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