In my nearly 20 years in this industry, and almost five years of teaching, I have come to the not-so-startling conclusion that there are two types of traders in the world – those that make money and those that don’t. I call these two groups the 90 percenters (the money losers) and the 10 percenters (the money makers). While these statistics on trading success are open to debate, they make it easier to demonstrate some common mistakes that unsuccessful traders habitually do.
A very common mistake that the 90 percenters do is change their reason for being in the trade. In every class I teach, this question/example is always asked, and without doubt, most of the students laugh and admit to making this very basic mistake.
When determining a trend, a trendline is often used to help traders enter or stay in a trade. The mistake is this: Staying in a trade after your trendline is broken, and drawing in a new, flatter trendline. (Flatter trendlines are bad, in both up and down trends). New traders will often be resistant to taking a loss, so giving the trade “just a little more room,” hoping it comes back, is a fundamental mistake. If your reason for being in a trade is no longer valid, your job is to take the small loss and move on to the next trade. It doesn’t matter if your reason is a supply or demand level, a trendline, or anything – if it’s no longer valid, it is time to exit.
Here is an example:
Entering a long trade at the trendline and demand zone intersection is a perfectly legitimate trade, with a nice small stop loss (~50 pips) and a decent profit target (~150 pips). This stays in our recommended Risk:Reward ratio of 1:3.
The new trader (or 90 percenter) will often draw in these new trendlines to avoid taking a loss. What should have been a small loss turns into a huge loss. The thought process is, “Maybe my first trendline wasn’t so good, maybe this new one is better…maybe my second trendline wasn’t so good, maybe this new one is better,” until finally the trader can’t take the giant red trade in their account. How many of you recognize this as a mistake you have made in the past?
One question that I ask nearly every day in class is this: How many bad trades does it take to blow up your account? The answer is one. Is it this one? As traders, we never know if this is the trade that will go against us 1,000 pips, 500 ticks, $50, or whatever it is; your job is to take the small loss and move on.
With the enormous leverage in the spot Forex market, allowing one trade to go against you can be the one that will blow up your trading account – sometimes in less time than it takes to go to lunch.
This was an example of drawing a trendline flatter to stay in a trade. Don’t do that. But, can you draw a trendline in steeper to stay in? The answer is yes. This is actually a good thing. In the spirit of the holiday season, I call it getting a gift. Occasionally the market will move in our direction very dramatically, faster than we expected. The market is giving us a “gift” of faster profits. The funny thing about the market is that the “gifts” it gives us has a time limit. If you don’t take the gift, the market will take it back, sometimes just as quickly as it gave it to you!
Here is the same EURUSD chart from late October of 2010. The trader goes long at the third touch of the trendline. When that trendline breaks, the plan would be to exit (if not much earlier)!
After the market decides to give the trader a gift, the trader will have drawn in steeper trendlines to stay in this trade. Again, steeper trendlines are good! On the break of the third trendline, the trader should exit part, if not all, of the trade, locking in a good profit. If the trader would have waited for the break of the original trendline to exit, he/she would have left ~150 pips on the table.
The takeaway is this – trendlines can be very helpful in your trading, as long as you use them correctly. Adjusting your reason for being in a trade – be it a trendline, supply/demand zone, whatever it is – to give the trade just a little bit more wiggle room is a 90 percenter mistake. It only takes one mistake like this to blow up your account! Also, doing this just once or twice a week/month/quarter can take away much of your hard-earned profits. How many of you had a few days or weeks of good trading, then did this common mistake only to give back those days/weeks of profits? Most traders I know have done this mistake at least once in their careers! Please don’t be the next person who sheepishly acknowledges this mistake as one you have done, or worse, continue to do!
Rick Wright can be contacted at The Online Trading Academy