A Double-Edged Sword: Cutting Losses

Part of my overall trading plan is to be very aggressive in cutting trades that do not act as intended. This is great as it has helped me cut my average losing trade from -0.75R to around -0.4R. However, it can be a double-edged sword as this week has shown.

Due to the dramatic increase in volatility, and the snap back rally in the indices, this has meant I got quickly stopped out of a number of trades late last week for small losses. Thursday lunchtime, the trades I was in were all in profit or at breakeven, yet by lunchtime on Friday I was stopped out of all bar one US position, which has barely held on.

Looking at the charts the trend has not necessarily been invalidated, but my own aggressive cutting of any losses incurred has meant that those trades have been exited.

It is worth recalling how these 'breakout stops' came into being. In 2011 I suffered from numerous failed breakouts in the choppy conditions we had for most of that year. Too many trades moved nicely into an initial profit before reversing (mirroring the indices), and triggering a high proportion of full 1R losses. This was as the initial stop used had not had sufficient time to move.

As my entries are based on breakouts from some form of consolidation zone, this means that, should price re-enter that zone, then I cut the trade. This basic idea I got from David Ryan's interview with Jack Schwager in Market Wizards, the rationale being that breakout level used (which for example on a short trade would have been a prior support level) had now failed to act as resistance.

The rally in the indices on Thursday and Friday last week (the Dow approximately 600 points from bottom to top, FTSE 250 points and the DAX 500 points) saw to it that my stops were triggered on some promising set ups.

This is something that, however frustrating it is, I must accept can and will happen.