Tuesday, May 1, 2012

Trade Management in Silver

I've had some questions about "Trade Management" and I think the recent developments in silver are good for discussion.  Trade management to me is all about when to flatten a trade, add to your trade, adjust profit taking targets, trailing stops, and most importantly, when to do nothing.

In the case of silver, the formation of a "Descending Triangle" after the "Head and Shoulders" allowed for the initial stop loss above the right shoulder to be trailed.  (See right hand side daily chart below.)  In my opinion a stop loss should be placed only at the point where the initial trade idea becomes invalidated by the market, and should never be based solely on an amount one can afford to lose.  One of my strongest beliefs is that a stop loss should never be trailed for the sole purpose of locking in gains or protecting profits.  How many times have you had a stop loss get taken out on a minor reaction after trailing it, only to see what would have been amazing gains left on the table afterward?  Small losses add up, and what could be a very good trading system now appears to be a poor one because of the use of trailing stops randomly or out of fear. 

Trading losses that are a result of an unexpected change in market behavior once a trade is put on are expected.  It is important to judge a trade by the decision made at the execution stage and not by the final result, otherwise known as "Outcome Bias".  Losses that come from repeated mistakes, poor risk management, and improper position sizing do the incredible damage in most cases. 

Once a trade has been put on I believe it is best to ignore random market behavior and give the probabilities for supply and demand, time, or room to work.  I am more interested in finding a continuation pattern to add to my winning trade, or a reversal pattern to close it out rather than worry about "profit" or "loss".  The focus must be on the auction. 

There are times when the break of a significant trendline happens barely by a tick or two (bull or bear trap), and price reverses immediately back inside the prior resistance or support area.  In those cases I might shut down the trade instantly, with the intention of re-entering again.

The greater the force behind a move in terms of price movement and volume on the break of a multipoint or significant trendline the greater the reason to sit back and wait for another opportunity to add to the winning trade because more may be coming.  This is the opposite of averaging down or adding to a losing position that has moved sharply against a trader.  Winning traders accept a loss with their smallest position.  Losing traders go broke adding to losing trades.

I'll sum it up this way, I want to "embrace" the risk of giving back profits in a winning trade, and "avoid" the risk of greater losses with a losing trade.

Back to the descending triangle.  I believe the most logical place for an initial stop loss on this pattern was located above the nearest reaction point to the upper trendline prior to the breakdown of horizontal support. 

There is no trade until there is a break in support.  The stop must be known prior to placing the trade.  "Accuracy" in the calculation and locations for position sizing and risk management are more important than "Speed" in my mind and that is why I want to identify opportunities early. 

What we have had now was a rally to the upper downward sloping trendline resistance again with a failure to break out or reverse the trend.  The stop loss in my opinion can now be once again trailed along the trendline to just above this latest reaction point. 

I have drawn an X and used an arrow to mark the moves. 

What does trade management in this example do?  It has left the initial trade idea working without the stop loss being executed in noise.  It has allowed the Head and Shoulders pattern to lock in a gain for good reasons.  The descending triangle pattern now only has a fraction of the initial risk taken.  This type of risk management and trade management I believe increases the overall "expectancy mean" to the trading system.

The head and shoulders and the descending triangle are still in play, which still gives me a bearish bias until the stop loss is taken out. I have no desire to trade to the long side in silver until then.

(Click on chart to expand)

I have been told that these other areas really differentiate my blog from the others they have read.  If you disagree with any point of view feel free to share.

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