The two most important things in trading

It takes some time for the two most important things in trading to hit home. It’s easy to understand the words, but the meaning and importance come later.

  1. Limiting loss with sensible stop-losses is of the utmost priority. With a 60 – 80% loss rate which is not unusual, that’s where any profits made on winning trades evaporate. So, it must be of the highest priority.
  2. Targets – sensible ones – are the next most important things. Targets are where you set your ‘take profit’ (There is one exception to this discussed briefly below i.e. trend-following trades).

Both things suffer similar problems i.e. how do you set reasonable stop-losses and how do you define reasonable targets. Get your stop-losses wrong and you lose too much in over 60-80% of losing trades. Set your targets too high and you miss them over in the 20-40% of winning trades; leaving the market to take back what you should have gotten.

Stop-losses are very tricky. Some traders insist that they must be limited to 1% or no more than 5% of existing equity on account. It’s difficult to set down hard rules about this. Each trader has to find what percentage of risk to take, based on their trading performance. Beginners should stick to the 1% rule. Seasoned traders can venture closer to 5%. Certainly 100% of equity is just plain dumb.

The one exception

In trend-following trades it is not possible to set a definite target in advance. Appropriate exit points become ‘targets of a kind’ – and these emerge as the trend unfolds. Nonetheless, limiting loss is still a big priority and staying in a trend longer than needed can lead to the market taking back what it owns.

Advice

This site does not give advice or tips. It’s not for this site to tell people how to set their stop-losses and targets.  That’s not what this site is about – and if you’re looking for that sort of ‘help’ do look elsewhere. This site is about extracting the core principles and we’ve already said that we don’t do teachings and courses.

There is no one sure fire formula that can tell an individual trader what’s a good stop-loss or how to set a good target. The issue is related to so much i.e. individual psychological factors, ATR,  market position, RSI, reward:risk ratio, available equity, expectancy ratio, important news events by central banks or directors of organisations (and the list goes on). How can any site or any guru adviser tell any trader about those variables?

Each trade is similar but different to any other. The factors that need to be balanced are complex. It is that complexity that turns off most people and explains (in part) why few become successful at financial trading of any sort.

But whatever the situation, new traders should really focus on getting their decision-making on the above points properly in order. The harsh and brutal reality is that nobody can do this for you – and if they say they can help you, we think you’re being set up.

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