Price has been driving lower for the last thirty minutes, price consolidates briefly, and you enter short on a picture-perfect pullback. Your stop is set several ticks above the swing high of the pullback. Price moves aggressively in your direction. You congratulate yourself for the textbook entry.
High fives all around! Trading isn’t as hard as everyone makes it seem. Now comes the hard part. Managing the trade for maximum profit. Do you set it and forget it or do you actively manage the position?
What you decide and how you decide to do it makes all the difference in what the actual profit or loss of the trade will be.
Although the focus in the trading community always sems to be on the trade entry trade management is actually where the money is won or lost.
On any given trade if one hundred traders enter the market at the exact same time and get filled at the exact same price it is possible and even probable that all one hundred traders will make or loss a different amount of money.
Think about that. Let the implications of that sink in.
Same Trade Entry Different Trade Results – Episode #1
Traders A, B, C and D all enter the above trade short on the pullback at the exact same price and at the exact same time. Their stop is several ticks above the swing high. In this example we will say that each of their stops is 10 ticks. Price moves forward aggressively after their entry for 12 ticks and then price stalls.
Trader A, who employs a discretionary trade management style, does not like the lack of follow through exits immediately on the stall for +10 ticks.
Trader B, C and D hold their trades. Price continues to stall then pulls back to the entry price and Trader B, who sets his stop to automatically move to breakeven once price equals initial risk, exits at breakeven for +0.
Traders C and D are still holding their positions. Price continues to pullback and trader C, who uses a discretionary trade management style, is no longer confident in the trade exits at market for a 5 tick loss.
Trader D, a “set and forget” trader, sticks to his system and holds his position. Price pulls back testing his stop but makes a double top with the swing high and then moves down aggressively. Price hits Trader D’s target at the next support level for +30.
In hindsight it is easy to say Trader D had the best trade management, but hindsight trading is for fraudulent trading gurus and chat rooms know-it-alls. Real trading at the right edge of the chart, in real time, is forward projections and probability plays.
In this particular trade things worked out best for Trader D, but the key is, “in this particular trade.” The outcome on the next trade, even if the setup is very similar, could be very different.
Same Trade Entry Different Trade Results – Episode #2
Fast forward 30 minutes. A very similar setup to the above presents itself. Now price has been driving lower for the last sixty minutes, price consolidates briefly, and Traders A, B, C and D all enter short on the pullback at the exact same price and at the exact same time.
Their stop is several ticks above the swing high and each of their stops is 10 ticks. Price moves forward aggressively after their entry for 12 ticks and then price stalls briefly.
Trader A, who employs an active scalper trade management style, does not like the lack of follow through exits immediately on the stall for +10 ticks.
Trader B, C and D hold their trades. Price continues down without pullback and at +20 ticks Trader B’s target is hit as he employs a trade management style where profit is taken at 2x initial risk.
Traders C and D are still holding their positions. Price continues down aggressively but turns abruptly right before the next support level. Trader C takes profit on a reversing pattern for +30 ticks.
Trader D sticks to his system and holds his position. Price reverses aggressively 5 ticks from target and pulls back all the way through the entry for a full stop out -10 ticks.
In hindsight, for this trade, it is easy to say Trader C had the best trade management, but again hindsight trading is for fraudulent trading gurus and chat rooms know-it-alls. Real trading at the right edge of the chart, in real time, is forward projections and probability plays.
In this particular trade things worked out best for Trader C, but again the key is, “in this particular trade.” The outcome on the next trade, even if the setup is again very similar, could be very different.
Rinse and repeat. These four traders could continue to enter the market at the exact same time, at the exact same direction and at the exact same price and each time end up with four different outcomes.
A Consistent Trade Management Style is the Key
The good news is that each of these traders can be profitable traders employing the trade management style of their choice.
The key is consistency. Pick a trade management style and stick to it. In any given trade your particular trade management style could be the best possible trade management style for that particular trade or the worst.
However, you will never know, until after the trade, so you have to play the percentages and be consistent with your trade management style. Sometimes it will end well and other times it will end not so well, but over the long run your trade management style should balance out relative to other trade management styles. Unless you constantly switch trade management styles.
Inconsistently in Trade Management is Just Another Way of Saying Failed Trader
The worst thing you can do is switch your trade management style every time you get a less than optimal result. Every trade management style gets less than an optimal result sometimes.
If you switch trade management styles after every poor result the fates will laugh at you and you are certain to shortly enter a trade where your current trade management style performs sub optimally while the trade management style you just abandoned would have produced a huge winner.
But seriously, switching trade management styles randomizes your results to a point where you can not usefully track anything. You need to stick with one style of trade management for a long enough period of time that you can get meaningful results to compare against.
The thing to remember is that trade management isn’t about one trade, it’s about managing your trades in a manner that allows you at the end of the day, the week, the month and the year to walk away with your total winnings greater than your total losses.
That’s the base line. Once you can get to this point then it’s a matter of honing your trade management such that the difference between the sum of your winnings and the sum of your losers gets bigger and bigger.
Two Basic Styles of Trade Management
At root there are two basic schools of trade management, mechanical and discretionary, and within each of these schools there are many subsets and variants.
Mechanical trade management refers to a preset bracket for each trade such that the stop and target for each trade is the same. A trader who employs this system of trade management might have a stop loss of 10 ticks and a target of 30 ticks.
Using this trade management style every trade the trader took would have a 10 tick stop and a 30 tick profit target and all his trades would either result in a loss of 10 ticks or a win of 30 ticks.
Mechanical trade management or “set and forget” as it is often called is where most traders should start and where most traders should stay.
This style of trade management focuses all of the trader’s energy on finding great set ups and entries after which, the pressure is off, either the trade works or it does not. There is a lot less stress using this trade management style.
Additionally, since there are no variables involved, either there is a full winner or a full loser, it allows a much clearer overview of the trading system’s true winning percentage over the long term. This allows the trader to do minor tweaks to the trading system and isolate the effects of each minor change.
There is a lot to like about mechanical trade management, so why would anyone utilize a different system?
Well the arguments against using a mechanical style of trade management is that once you enter a trade price may present subsequent information which invalidates your original market analysis and there is no reason to take a full loss when you could have exited for a partial profit, breakeven or a partial loss.
Conversely, sometimes information will present itself after trade entry which shows that the original profit target will be greatly surpassed and there is no reason to only take a set profit when the profit could be much larger.
Keep it Simple Stupid
In theory this sounds valid and great. Why take a 10 tick loss when you could take a 5 tick profit instead or exit at breakeven or a partial loss? If real trading moved in neat linear patterns than this would make sense and be easy.
But real trading is messy, sloppy and overlapping. How successful a trade looks like it is going to be halfway through a candle may look totally different once the candle closes.
Once you start messing with the variables you are also messing with the percentages and what started out as a clear cut 3:1 risk/reward ratio now becomes something totally different. Something only knowable in hindsight something that cannot be projected forward as it is always changing.
Remember, you will be at your best before the trade. Your analysis, your thinking, your rationality and your risk assessment will all be at their sharpest and most unbiased before you enter a trade.
Once you enter a position and have live risk it’s a whole new ball game.
Emotions intensify, fear and greed rear their ugly hungry heads and your decision making is adversely affected. Now, if you are not careful, every little twitch in price looks like a signal to snatch profit while you can or to hold on because this is going to be the huge runner you have been waiting for.
Discretionary Trade Management -For Experts Only
After reading that you might be wondering, “why would anyone not use a mechanical trade management style?” The truth is most traders should use a mechanical trade management style, but for the advanced trader the profit potential increases under a discretionary trade management style.
Discretionary trade management is as the name implies a trade management style where the variables are at the discretion of the trader.
The trader at their discretion may choose to vary the initial stop loss or initial target or once the trade is entered the trader may take profit before the target is reached or move the target if price looks as if it is going to exceed the initial target. Likewise, the trader may move to breakeven or take a partial loss at their discretion.
As you can see there are a lot of variables, which sounds great and is great in the hands of a seasoned trader with a well throughout methodology on what events will trigger what actions on their part.
A seasoned trader can use this discretion to capitalize on huge moves to capture oversized profits or to capture some profit on days when a mechanical trader would get chewed up in the chop of a tightly ranging market.
But this is easier said than done. What actually happens when traders try discretionary trade management before they are ready is the exact opposite. Emotions take control and trades are exited at the exact wrong times.
Winners are cut short and losers are allowed to run. A trader is up 30 ticks and decides to hold, but then price pulls back and the trader scares out and ends up taking profit at 10 ticks or breakeven only to see price continue on.
The trader missed out on the original 30 tick profit target and also missed out on the big move that happened as they anticipated.
Now said trader is somewhat angry and wants revenge.
The next trade the trader is again up 30 ticks but forsees another extended move. Price pulls back, but this time the trader is determined that the market will give them what they are owed.
They sit through the pullback and then sit some more only to be stopped out for a full loss. The market gave them exactly what they were owed.
They missed out on a full 3:1 profit because emotions came into play. This is the danger of discretionary trade management. And it can quickly spiral out of control.
Building up to a Discretionary Trade Management Style
Discretionary trade management is what all traders can aspire to, but it is something you have to grow into, not start with.
If you currently employ a mechanical trade management start by reviewing the trades you took in the last month. Go back and replay each of these trades in replay mode, if your trading platform allows, and see how your results would have differed using discretionary trade management.
However, be aware that this is hindsight trading and knowing the future path of price will give you the confidence to told positions you would not have held in real time.
If you are still convinced you want to move towards a discretionary trade management style now either go to SIM or trade very small for 10 trades using discretionary trade management.
What to Focus On
The key is your trade review. For each trade in your sample and for the sample overall you want to focus on:
1)your emotions
2) your process
3) the results
First, how did managing your trades this way make you feel? Are your emotions heightened, did you feel more reactive more euphoric more fearful? Heightened emotions are not a good thing in trading. Being aware of your emotions is the first step then controlling for your emotions follows.
Second, how was your process for discretionary management? Do you have an if/then checklist? You need one. If price does this, I will then do this. Did you follow your checklist? Why or why not? Hint see step one for emotions if you didn’t follow your checklist.
What do I need to change about my if/then checklist? Only change one thing at a time so you are better able to track how said change effects results.
Third, how were the P/L results of the trades compared to the P/L results using your mechanical management style? For each trade you need to compare the results of the discretionarily managed trades with how the trade would have resulted using your usual mechanical trade management.
Over this small sample how were the results different? What was the winning percentage and the average loss and the average winner?
Now repeat this process for another 10 trades and review results using the three areas of focus.
Rinse and repeat again and again.
Eventually, you will develop a discretionary trade management style that works for you or you will decide that mechanical trade management works best for you. You can be a successful trader either way you just need to find what style of trade management is best suited for you.