One common mistake most new traders and even some experienced traders make is to add to a losing position!
In early years of my trading, I heard about this in a number of seminars and training sessions I attended, and read about it in a number of books and material available on the internet.
Yet for some strange reason I often used to find myself susceptible in this practice! Maybe the reasons were to do with a little bit of maths and the hope (or stubbornness) that my idea to enter the trade was right in the first place.
Let me explain both aspects with an example – I enter a trade say long euro from 1.3230 based on a well thought out strategy with a 30 pip stop. As the trade starts going in the opposite direction, I look at the reasons why I entered the trade and they are still appearing to be valid. The trade moves about 20 pips against me and I am getting nervous. This is when the maths kicks in and I add to the position taking another long position at 1.3210. The logic is that if the trade moves in my direction I will be at break-even on 1.3220, which is 10 pips below my original entry, and if it continues I will make double the profit for same pip movement. Perfectly valid logic! I think this is the trap which makes traders commit this commonly known blunder. An important aspect ignored while adding to a losing position is the fact that the risk has been increased. And if the trade continues in the wrong direction, it loses money at faster speed.
The other aspect is the unwillingness to accept that I am on the wrong side of the markets’ collective sentiment. Once in a trade I only look at my own analysis often ignoring other signals.. For instance, I may have ignored how charts were setting up in other timeframes than the one I based my decision on, or perhaps I did not pay attention to important news scheduled around the time! Often once in the trade, people get emotionally attached to their position and don’t want to consider that they could be wrong. Whatever the reason, the key thing to remember is that markets’ price action is what decided whether you are going to have a winner or a loser. , and that there is no guarantee the trade will revert to a favourable position. After all, there is a reason why it moved in opposite direction in the first place. The Mind plays funny games in these situations and it is hard, very hard to take an objective decision.
Whatever the justification – the bottomline is increased risk and increased increased level emotional turmoil during the trade, (and after you happen to lose.). And it case it turns out to be winner, it is even worse – because the result has just created a reinforcemnt for what is a bad trading habit. So beware!
So to summarise, here are the high level lessons which I will share with you in greater detail on the training course:
- Make sure you know the reasons for entering a trade. Re-check your analysis and decide your entry, stop and target etc before entering
- If the trade starts going against you:
- Do not add to a position just to average down
- Re-check the reasons for entering; look at different timeframes and other factors
- Cut the trade if you have doubts about validity of trade idea