The number 1 sin of a trader?

Last week, we opened the doors to our live trading room giving visitors access for a couple of days. We periodically do this as it allows people to see what we do on a daily basis. The questions we often receive whilst visitors are in are diverse and probing which makes for very interesting sessions when we are not in the middle of trades.

[Join Charlie in the trading room for next scheduled free 2 day event]

One visitor made a comment about the use of stops which pricked up my ears immediately. He stated that he used ‘mental stops’ instead of physical ones because he felt that if he placed physical stops, his broker would somehow manage to move the entire FX market in order to stop out his position!

He would have a level at which he would manually close his position and he had in fact had a good run over the past several months. But…. What would happen if he had a power cut or his internet went down just at the time the market was moving against him? How long would it take to get through to his broker to close the position? If the market was moving fast, he could find himself taking a bigger loss than he wanted.

However, there’s a much bigger problem with using mental stops. At some point in the future, he’s going to get over-confident (it always happens) and when a position moves against him and runs fast through the level he might normally close out, he decides to wait. For whatever reason on that specific day, the trading stars will come into alignment to get him. Maybe he got out of bed on the wrong side or maybe a cow flew over the moon, whatever the reason, he elects to wait and see because so often the market will come back in his direction anyway….

On this special day that the daisy flew over the moon, the market decides not to bounce, in fact it presses on against his position like the red arrows in strike formation; fast and aggressively. He now doesn’t know what to do, the position is seriously under water and yet the market keeps pushing. He sits there in a cold sweat, cursing why he didn’t close out earlier and hoping the market will still turn around for him.

It has a couple of small bounces, only to head lower once more. He still can’t bring himself to close his position which would now give back a months prior gains. So he decides to wait until the following day because if he keeps his cool, the market is likely to still bounce. The following day comes (after a stressful night’s sleep) only for the market to drop lower again. He’s now really in the hole. He had decided to add into his original position because that way it doesn’t need to rally as far to recoup his losses. Now the market is falling with him in a much bigger position he should be in still with no protection. I’ll cut the story short here because we all know what happens eventually – he blows a significant amount of his account and gives back several months or a year or more of gains (if he’s lucky).

Although in the short term, using mental stops can work, traders are putting themselves at serious risk that at some point in the future, it will all fall apart and that’s why if you speak to any broker, they will tell you their clients who don’t use stops always end up losing. There’s no need to not use stops, they are there for good reason…..

Looking at the currencies, I’ve selected cable this week for observation. It’s been chopping either side of its 50dma lately (black line) but looking at the bigger picture, its trading within a descending trend channel that I have marked on the chart. I’ll be keeping my eye on whether it comes down to the lower trend line or rallies to the upper trend line. In either scenario there will most certainly be buying or selling opportunities….

Have a great week

Charlie Burton

Ezeetrader

[Join Charlie in the trading room for next scheduled free 2 day event]