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I often get asked by traders why they keep on getting taken out of positions too early, only to see the price continue in the original direction. 

It is an interesting question and it is my belief that the major reason for this is that people do not adequately consider all things before placing an order, before trailing their stop or indeed using Take Profits.

It seems that the issues relate back to 2 separate issues with a common link:

Stopped out too early

Close the position out too early

Before we go into the 2 issues, it is my belief that EVERYTHING we do regarding trading should be relative to price action and the basis of both these issues can be found in the fact that most traders ignore this piece of advice, and use arbitrary values rather than using values relative to the price action on that instrument at that point in time.

Stopped out too early

ISL (Initial Stop Loss) too close – tight stop

TSL (Trailing Stop Loss) too close – fear of pullback

Tight Stop

I personally cringe when I hear someone say that they are going to use what they call a ¨Tight Stop¨

One of the most common causes here is the idea that risk is more easily controlled with a ¨Tight Stop¨ this is a total fallacy and is counter productive as this process generates more losses than it protects from.

ISL´s which are placed based on Arbitrary values, do not allow the price action to breathe, and usually the stop gets hit on most pullbacks.

Price frequently triggers an entry and then retraces, and what it does from that point is pure price action and a Stop that is an arbitrary value and is not relative to that price action usually get taken out prematurely.

ISL´s which are set according to Price action are wider and therefore the position size is smaller – BUT price tags the stop much less frequently – therefore – providing the analysis is correct – you do have a much higher percentage of winning trades. 

As an example here – GBPNZD can move 400 pips in 1 day – I have had many trades on this pair with a 300+ pip Entry – Stop spread, and 1 trade on this pair with a 495 pip Entry – Stop spread.    

The position sizes were not huge with this pair, BUT the reliability of this pair when it is bouncing from Significant Support or Resistance levels is huge with a minimum of 2 runs each year in excess of 1300 pips each. 

I did a Guest Trader webinar for a group on Risk and Trade Management and will post the link below, 1 of the trades shown in that videos is GBPNZD D1 from September – December 2018. During a run that was in excess of 1700 pips, I entered 4 positions and extracted around 1588 pips from the 1st position – however extracted an additional 2000 pips from the next 3 positions – Totalling around 3600 pips from that single run.

Each of these positions and the Initial and Trailing Stops were all relative to price action. 

https://petervarcoe.com/risk-and-trade-management-webinar/ 

The complete trade management of these positions is discussed in the webinar, and if you are experiencing any of these issues discussed here, you may be able to learn something of value. 

Fixed Lot Sizes 

Another cringe worthy reason for being stopped out too early is that people also use fixed lot sizes and adjust the stop to fit trade risk amount. 

This methodology is an anathema to Risk Management, as all it does is limit the loss to a set value, and greatly increases the ratio of Losses to wins, which is far from good risk management.

Because the ISL is being manipulated to fit an idea and is not in any way relative to price action, the ISL value is also an arbitrary value and will get tagged out more frequently than necessary. 

Proper Risk Management requires that the entry is determined, the ISL is placed relative to price action and the position size modified to fit the Entry – Stop spread. This greatly increases the ratio of winning trades to losing trades.

Risk Management is NOT JUST about limiting the loss on a single transaction to a selected amount – it is ALSO about limiting the number of losses and maximising the number of winning trades.

Close the position out too early 

I am often asked how traders can avoid closing their positions out too early as they see the price continuing after they exit the position

Positions get closed out too early for several reasons:

FOMO

Not understanding Price Action

Profit Limiters

 

FOMO

FOMO – Fear of Missing Out, is normally a result of inexperience.  

The trader sees price action heading in the right direction, then pulling back, and they react to the pullback, without understanding that price seldom drives straight through to the point of directional reversal.

Price Action normally pushes in the direction, then retraces / consolidates prior to continuing – for those that don’t have the experience it is these pullbacks that generate FOMO, based on the value of the open position – they only see the value declining and close the position prior to its continuation – thus missing out on more profits. 

Not understanding Price Action 

This is similar to FOMO, in that the trader is not able to read price action and relate the current action to where the price is in the cycle of running up or down, and frequently happens mid trend.

Frequently what happens here is that the trader is watching the position develop, and normally moves the stop in closer when retracement is commencing and the stop ends up too close (Tight Stop) and ends up getting tagged prior to price direction continuing.

All traders should strive to learn to read price action because there is no size fits all – every instrument has its own differentials EURUSD is very different from GBPNZD as an example

If using trendlines as a Boundary use the extremity of the price action instead of the extremity of the candle body – using the highs and lows is much more accurate, then realising that the price action can rise and fall back to the trendline many times in a single run. 

Profit Inhibitors 

Profit Inhibitors – aka – Take Profit levels

Profit Inhibitors can be quite valuable when scalping, but if you are trading Trends or continuation patterns – they live up to their name – Profit Inhibitors.

With these levels, the concept is to close out part of the position, taking that profit and letting a smaller position run – usually with a tighter stop, and this position then becomes a self-fulfilling prophecy. 

When trading trends I tend to look for 3-5:1 RRR (Risk Reward Ratio) – most who use TP´s (Take Profit’s) never get to those RRR levels for the simple reason that many times these Inhibitors are set at 1: or 1:1.5 RRR. 

Personally I believe in the very sound adage in the Trading industry – Cut your losses short, BUT Let your profits run.

Using Profit Inhibitors is in direct contravention of this adage.

I have held Equities positions where the values have doubled, trebled and had 1 Equity position where the value went up to 6 times the initial entry value – these results are automatically cancelled by predetermined levels of exit.

 

Conclusion

Overall, each of these issues can be circumvented by learning to read price action, and understanding what it is telling you, and understanding how you can exploit that price action.