Today, I will share a little about my thought process in managing losing trades.
I took a short position on the US TECH 100 this morning. I sold it>3944 for $50. I was expecting a price drop. This expectation was derived from my analysis this morning and also based on historical price action of all 4 of the ‘BIG PLAYERS’ which are the Wall ST 30, US TECH 100, US SMALLCAP 200, and the US 500.
My initial analysis was wrong. Instead of holding the trade all day, after it had made a significant run up, I decided to close that trade at a -$25 loss and open another sell trade at a higher price. The reasoning behind this was since the US TECH 100 had moved beyond what i thought was a normal distribution of prices, the likely hood or probability of that security closing below my initial entry was deteriorating each point it moved up.
By doing this, I accomplished 2 things.
1. I limited my losses by closing the first trade. The farther it gets from the entry point, the faster it begins to lose money. Also as the day goes along, the longer it is OTM or out of the money, the faster time decay works against the trade.
2. I had a second chance at a profitable day and a better probability that today would be a successful day. Even though I can not make the initial $50 profit per contract now due to my previously closed trade, I still have the chance to make $25 per contract (based on all trades combined).
By closing out the first trade and opening up a second one in this manner, the probabilities of success go up dramatically. The odds of the US TECH 100 closing below my second entry are much better due to the fact that the second entry is closer, basically. I do not have the math equation for this.
Now if my second trade reaches a loss level of -$25, I will close the trade at a loss. This will mean that I now have 2 closed trades…both losers. However, the losses are -$25 versus $50. With these probabilities, a trader has to be correct only 33.4% of the time to break even. If he is correct on the trade ideas 50% of the time, he will become a millionaire.
Trading successfully is not about today. It is not about this week. Each trade is insignificant in the long run. To become a successful trader, either you have a high win percentage or a low money loss per trade percentage. Average them out over hundreds or thousands of trades and the truth becomes known.
If I lose my trade today, that’s no big deal. Here is why…
Over the course of 1,000 trades if A trader wins 50% of the time (a coin flip)…
500 are -$25
500 are +$50
Net profit on 1 contract = $12,500
Net profit on 10 contracts = $125,000
Net profit on 50 contracts = $625,000
Or lets pretend A trader wins 60% of his trades….
400 are -$25
600 are +$50
Net profit on one contract = $20,000
Net profit on 10 contracts = $200,000
Net profit on 50 contracts = $One million
My trade is not closed yet. Happy Trading!!