WE ALL know what most traders do wrong: they trade against the trend, their average gain is usually twice the average loss, and they will add to losing positions. And the most televised way of turning profitable is to adhere to the two first rules, while avoiding the third. There is nothing wrong with this, but it will often take some time to accumulate gains: they will not be too spectacular and, in a weak trending market, many small losses will usually dilute the few good trades.
One way of combatting this is to add to winners instead. Yet most people are afraid to do this, and it’s probably the least promoted way of trading. In fact, most people prefer to book partial gains and then move the rest of the position to break even. This means that they will usually take a full loss when they are wrong, and only get 75 per cent of the potential gain if correct. This is why it might make sense to experiment with adding to winners, instead of closing them out.
If a trader starts out with a 50 pip stop loss on a position, expecting price to rally with 150 pips, it will usually be possible to reduce the stop loss when the position moves in the right direction. By reducing the stop by 25 pips, say, risk will have been reduced by 50 per cent, allowing the trader to increase the position by 50 per cent. At one point the position will be risk free, but the trader will have increased the original position by up to two times the original size. This goes hand in hand with rewarding your winners and is what I have recently heard coming from the mouths of successful traders.
Alejandro Zambrano is a currency analyst at DailyFX. He leads DailyFX’s Premium Educational Seminars – http://bit.ly/PremiumEDU