The challenge of forex trading is greatest when a trader has put on a position and it has moved the other way. The response to adversity is the true test of your grit and intellect. To help in such trying times, this column is dedicated to offering a few strategies for when the losses are piling up. Here are the traditional methods of limiting losses:
Stop losses:
Stop losses put in place passive controls. When you enter a position, you can put on a stop loss. One rule for stops is when buying, for example, you would put on a stop at the previous low or support point. When selling, you would put on a stop loss at the previous high or resistance point. This enables control against extreme moves. It doesn¹t guarantee precise control because, depending on your broker, most stops become market orders when touched. In an extreme move, your stops will be touched and the actual fill price can be far away. A negative feature of stops is recent support and resistance points often dictate that they are placed close to the market, causing the stops to be frequently hit. Many experience getting stopped and in minutes watch the market move in the direction they originally expected.
Stop loss and reverse:
In this variation, you place your buy or sell entry and put on your stop with an extra lot. For example, buy one euro at 86.50 and sell two euros at 85 95. This strategy keeps you in the market and reverses your position. It doesn¹t stop the possibility of the market whipsawing back the other way, of course.
No stops. Put on your position and leave it alone. This strategy lets the market work. There are two disadvantages: A) When the market moves violently, you are stuck on the wrong end. B) Your stomach lining is put to a test. Few people can look at a position long that reminds them of losses. The advantage is that currencies oscillate in time and have a wide range. If you are focused on a longer time frame, the price will tend to stay in the trend direction that is dominant.
Hedging:
Fortunately, there are alternatives to these strategies. Traders are not limited to these three choices. We call this new risk management technique Simultaneous Buying and Selling or hedging. This is possible at some e-forex firms. “There are several reasons why having a hedge position is so practical to our clients,” Plaut says. “The first is the psychological benefit of always being involved in the market. Even though the position is hedged and the client cannot lose money due to an adverse market move, he is still emotionally involved in the market and can adjust the hedge according to how the marketing is evolving. The second is the ability to stay involved in the market during a range-bound market. This tool helps the trader avoid whipsaws, which is one of the traders’ worst enemies. ”
In this strategy you enter a position and if it moves against you, you enter an opposite position. They will not cancel each other out. The buy entry position appears with the sell entry position on the account. What this does is, in effect, freezes the action and allows the trader to manage the risk slowly. Say, for example, the buy side is moving into profitable territory. You would leave the sell side alone and add to the buy side. Invariably, the market moves back and then the sell side can be traded when it becomes profitable.
The power of this approach is that it allows the trader to evaluate market conditions and not be slave to those conditions. It is up to the trader to decide how to balance each side.
A full hedge is possible where both the buy and the sell sides have the same positions. This freezes the P&L. It does not freeze the positions. If a profit on one side quickly appears, it can be closed and booked. You can add more to one side and favor one direction over the other.
One of the best applications of this technique is during a trading-range pattern. When there is no clear way to go, put on both a buy and a sell and let the market come to you. To make this work, you need a lot of intestinal fortitude!
While not foolproof, the ability to be on both sides of the market, at the same time is a tool that is rarely used, but likely can be exploited for more profits by most traders.
