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Forex Trading Strategy – A Trading Resolution For Us All
This week the Wall Street Journal ran an article regarding the best way to keep a New Year’s resolution. The gist of the story is summarized below:
When setting a resolution, simply deciding to change your behavior may work for a while. But when the cognitive parts of the brain responsible for decision-making become stressed by other life events, that resolve is likely to succumb to an emotional desire for instant gratification, says Baba Shiv, a Stanford University marketing professor who specializes in neuroeconomics, the study of the biological bases for making economic decisions.
Keeping a resolution requires a detailed plan, with emotional rewards when milestones are reached—and even a strategy when there’s a setback. And don’t wait for Jan. 1, experts say: Start planning now to increase your chances for success.
Keeping a resolution isn’t a 100-yard dash. It’s a marathon,” says John Norcross, a psychology professor at the University of Scranton in Pennsylvania.
I thought hard about this story as I reflected on yet another year of trading. My greatest weakness -- and I am sure I am not alone in this -- is my horrible habit of adding to a losing position. Over the years II have become much better at curtailing this behaviour, but I continue to make this mistake on more than one occasion.
Although the article suggests that we focus on rewarding good behavior in order to adhere to our resolutions, I think when it comes to averaging into losers we should instead scare ourselves straight into understanding the true risk of this strategy. The reason why we like to average into losers is because we are often able to get away with it. The natural ebb and flow of the markets rescues us from certain loss and we wind up walking away with a few pips of profit. As soon as the position is closed and we breath a sigh of relief and instantly forget the idiocy of our actions.
But in order to stop this bad behaviour we need to truly understand its consequences. Suppose you traded with a 20 point stop and 20 point target. One loss would require only 1 win to offset it. Even if you used a negative risk reward ratio of 1:2 it would only take two trades to offset the loss. Now suppose you got yourself into a trade that moved against you but instead of stopping yourself out at -20 you moved the stop back to -40 and added another unit. Then again at -40 you became even more convinced that a turn your way was near and set the stop to -60 adding yet another unit. When the cold hard reality of your actions finally hit you you would be out -120 on that single trade. It would take you 12 consecutive winners to bring your account back to breakeven.
Talk about digging your own grave.
Yet in the heat of the battle we never consider the true risks of our actions. All we care about is getting out without a loss. But in fact, we have already lost. As anyone who has ever averaged down into a position knows, in the end the trading gods always ruin you. Paul Tudor Jones once said, “Only losers average losers.” As we enter 2011, let that be a trading resolution for us all.