Hello traders! This week’s newsletter will be discussing how to add to your winning trades properly.
I’m sure by now most of you have heard some of the tired old phrases in trading like; let your winners run (true); cut your losses quickly (true); the trend is your friend until the bend at the end (true); trading is a zero-sum game (false); but there are a couple of phrases that most haven’t heard, and some of them could save you from losses.
The first is, amateurs go broke by taking large losses. This is VERY true. Most new/amateur traders are very quick to take their profits, showing a fear of giving back any small gains. Imagine you are up 20 pips, yet your target was 100 pips away. Perhaps you had a PLANNED reward to risk ratio of 3:1, but as your 20 pip profit slowly deteriorated to 15, 10, then only 5 pips you quickly closed your trade. This is taking a small profit, yes, but it will affect your REALIZED reward to risk ratio. New or amateur traders will also often let their losing trades approach their stop loss, yet, instead of taking the small loss they will move the stop farther away a few pips! So, instead of a 30 pip loss they wind up with a 40, 50 or even a 100 pip loss! This will cause amateur traders to go broke very quickly.
The second phrase most haven’t heard is, professional traders go broke taking small profits. This means that an experienced, profitable trader may be making a few pips on a weekly basis, but is it enough to finance their lifestyle? In my 22+ years of trading and teaching, I’ve met hundreds of traders who make a few pips a week. Which basically means they are trading on the side. So, assuming everyone wants to make more pips, let’s discuss one way to do that.
So, now it’s time to talk about how to add to our winners…almost. First, I need to show you how NOT to add to winners. For simplicity’s sake, I’m going to just use basic math, then we’ll get to the chart.
Imagine you buy something at $10, with the expectation it will go to $20, and your stop loss is at $9. You buy 1 lot. Price moves up to $13, pulls back to $12, then you buy 2 MORE, and you adjust your stop to say, $11. Your average price is now $11.33!, ((1×10) + (2×12))/3=11.33. Do you see how close your cost/price is to your stop?!As you add more lots at each new pullback it is possible to add incorrectly (buy 1, then buy 2 to have 3, then buy 3 to have 6, etc.), causing your average cost or price to end up being TOO CLOSE to your stop loss. One quick move in price the wrong way will take you out of the trade, very often for a loss, which I don’t think is the plan. So, how should you add to a winner?
How to Maximize Trading Profits
When adding to a trade to maximize profits, the goal is to avoid calculation errors by keeping the math relatively simple. By starting with one lot, then only adding 1 lot, going the right way, every time you add to the trade, you accomplish that goal.
Another way to increase your winnings on a trade while keeping the math simple is, for example, if you started with 4 lots, then you add 3, then add 2, then 1, then 1, then 1….until you finally get stopped out.
Rules for Adjusting Your Stop Loss
For long trades:
- After each add to a WINNING TRADE (we never add to losers), adjust your stop loss size to the new current position size.
- Make sure your stop loss is ABOVE the average cost/price of the total trade. Your brokerage firm will show you what your average price is. Why above? Because if the price does reverse, you want to guarantee at least a few pips.
For short trades:
- After each add to a WINNING TRADE, adjust your stop loss size to the new current position size.
- Make sure your stop loss is BELOW the average cost of the total trade.
Additional Rules for Adding to Winning Trades
Some traders have success with this technique WITHOUT placing a profit target in their platform, only having s stop loss. However, when looking at your charts, to be successful, this trade must have a potential of much more than a 3:1…very often, a 10:1 is a possibility from your first entry! This basically means these trades don’t show up every few minutes.
Another potential rule to follow is to only start this trade technique AFTER a longer term trend has broken, and it looks like a NEW trend has begun. This ties back into the just mentioned rule above.
Here is what it could have looked like on the USDJPY 120 minute chart:
At the lowest yellow demand zone, green 1, an entry buy order could have been place at 111.15. As price is moving your direction over the next couple of days, you should have moved your stop loss first to break even, then up to lock in a few pips. This has not been marked on this chart for clarity’s sake.
At the next yellow demand zone, green 2, an entry buy order could have been placed at 112.50, bringing your average cost to 111.825. Your stop now should be ABOVE the average cost of 111.825, but BELOW the demand zone you just used for entry. Again, not marked on chart, but the stop price would be approximately 112.35.
At the next yellow demand zone, green 3, an entry buy order could have been place at 113.35, bringing your average cost to 112.33. Your stop should now be ABOVE the average cost of 112.33, but BELOW the demand zone you just used for entry. Not marked, but it should be approximately 113.25.
At the next yellow demand zone, green 4, an entry order could have been placed at 113.65, bringing your average cost to 112.66. Your stop loss should now be ABOVE the average cost of 112.66, but BELOW the demand zone you just used for entry. Not marked, but it should be approximately 113.35.
Notice the same demand zone, but where the green 5 is located. Personally, I won’t add to a winning trade in THE SAME ZONE as where I just added. Spot 4 makes sense to add; spot 5 would be in the same zone so it does not make sense to add to your trade here.
At the large red candle under the red 6, we should have been taken out of our trade, around our 113.35 stop loss.
When done properly, the only time you can take a loss on this position is when you first enter the trade! If the zone at 1 hadn’t held we would have taken a small loss. However, when we add to our trade following this strategy and adjust our stop loss according to the rules, in normal markets our stop loss will only be locking in profits along the way! Now, you must be aware that this refers to the ENTIRE position; we will ALWAYS take a loss on the LAST ADD to this position. This is another reason we don’t add to our trades with the 1 + 2 =3 +3=6 technique. If we KNOW our last add will be a loss, why would we have that loss be on a large portion of our entire position?
Using core strategy techniques, current students of Online Trading Academy should be able to spot a couple more entry points on this chart, however, this example has been done with simplicity in mind. Hopefully this new technique will bring you a few more pips in 2019!
Until next time,