Trading Out A Losing Position

How long have you been trading forex? Maybe some months! Maybe one year! There may come a point in your trading career when you find yourself in a trade that is deep underwater. If you continue with the trade you may get your account wiped out. One of the most important lessons any forex trader needs to learn is how to get out of a losing position. This type of a situation may develop very soon in your trading career.

What we are talking about is a run away position that has the potential of wiping out the equity in your account. Can this type of a situation develop? Let’s suppose that there is a run away trade confronting you. Although in my opinion if you follow proper money management rules, this type of situation should never arise. What can a trader do when he/she is faced with such a run away trade? Most traders have two choices when holding onto a big loser.

1) Cut the position immediately and avoid a huge loss.
2) Try to average down and hope for a turn around in your favor.

You should accept a big monetary hit in first instance. You should place all your chips on the table and hope for the best in the second instance. Neither approach is attractive. Good news for you. There is a third way those great traders always use.

Great traders slowly begin to trade their way out of a losing position once they realize that the market has proven them wrong. Great traders simply refuse to take an outright loss by way of a stop.

Without adding to the position once you realize that you have a losing position that you need to get out, your mission should be to better your average cost. Adding to the position will only create more pain and sorrow for you.

You need to cut part of it to create a more breathing room for yourself. After that you should be able to trade out of the rest. Adding to a losing position can also quickly take away your flexibility as the loss grows and becomes unmanageable.

How can this happen? I mean how can such a situation develop? Let’s suppose that you had gone short in a downtrend. After sometime the trend suddenly reversed and turned into an uptrend. Now you are in a losing position because the trend has reversed. You have three choices with you. Read all the three carefully as this situation may indeed one day confront you.

1) Hold onto the losing position and hope that the trend will again reverse itself before you receive your margin call.
2) Get out of everything and take a substantial loss.
3) Cut part of the position on any reasonable dip.

What is a dip? It is when the market consolidates after an uptrend or a downtrend. What are the benefits of cutting your position on a dip? There are two benefits of cutting your position on a dip. Firstly, you are in fact freeing up liquidity to react to future price moves although you are going to take an initial loss. Any move now is a good move.

This simple step can now help you by reloading at better selling levels to improve your average cost if the currency pair bounces higher. On the other hand, if it immediately collapses then great, it is moving in your direction.

Loss is always painful. Seeing an unrealized loss is stressful. It might compel you to take hasty trading decisions. One of the most stressful aspects of trading is the psychological impact a running loss may have on your trading. The other great aspect of cutting part of your position is that you instantly take some of the stress away. Faced with a big loss, most traders are keen to take a needless hit and stop the pain immediately.

How do you deal with a run away trade? Let’s take a run away trade example. Suppose you trade EUR/USD pair. You are quite conversant with EUR/USD fundamentals and technicals. Suppose you believe that the currency pair EUR/USD is overbought and is near the top. You believe the rate may fail near the resistance level 1.2453. You take an initial short at 1.2433.

You are looking for a swing trade back to the support level 1.1983. This will give you a 450 pip profit when you close your position on reaching this support level. Your plan is to scale into the position. This is your first shot. You want to stay flexible.

You have done the scenario planning. You expect that the maximum the EUR/USD rate would go is up to 1.2583. You place a 150 pips stop loss at 1.2583. This gives you a risk/reward ratio of (150/450=) 1/3. This risk/reward ratio is really good.

You are prepared for a initial EUR/USD pair rally up to 150 pips. However, EUR/USD rallies taking out stops to print a new high of 1.2490 on reaching 1.2453 resistance level. You are not surprised. You knew it could happen so you had placed your initial stop loss at 150 pips.

You have planned two more lots. This is the point you enter the second lot into the market by going short. You take advantage of the higher levels to place your second short at 1.2493. You replace the stop loss of 150 pips with two stop losses of 75 pips each (150/2). Now you are two short at an average cost of 1.2493+1.2433= 1.2463.

All the time you are expecting the trend to reverse itself. When trend reaches the level 1.2383 (70 pips below the initial resistance level of 1.2453), you plan to place a third short since that will be an indication that the momentum is picking up steam to the downside. The EUR/USD pair begins to sink. You are happy.

The EUR/USD pair does not break that level. It rebounds at 1.2463 and is soon testing the highs again. You are unfortunate again. During this rebound you can choose either to cut the trade at cost or stick with it. You could have closed your position at 1.2463 taking a loss of 30 pips on your first short and a profit of 30 pips on the second short to end up with a zero loss.

You could have used the rebound to get out of the trade with zero loss. You did not close your positions instead you had decided to let the rate go up with a belief that the pair will rebound after going beyond 1.2500 level. The rebound does not take place and the rate continues to go up and reaches the 1.2470.

You have one more lot with you to trade. You decide to throw all your cards by going short again at 1.2473 as still you are expecting a rebound around 1.2503. Now you are short 3 lots average 1.2503+1.2493+1.2433= 1.2466.

A strong uptrend has developed. The pair EUR/USD continues to go high. It reaches 1.2480. You again reduce your stops to 50 pips each for the three lots (150/3=50). Now you make a strange decision against all your training as a forex trader. You decide to disregard all the money management rules and remove the stop with the belief that this high rate for the pair EUR/USD is unsustainable. The pair is overbought and it will reverse soon. You are very sure of the fundamentals and the technicals. This will give you the time to cut your position when it does.

Never ever fool yourself by thinking that the market will do exactly what you want it to do. Whenever the market is faced with something it can’t do. It proceeds to do exactly that. Trying to out think the market is never a bright idea. This is because the traders just like you who have been caught on the wrong side of the market are all sitting on the same trade and are vulnerable.

The equity in your account is in danger of getting wiped out. This simple trade is now looking like it may very well take a large chunk out of your account. The EUR/USD rate reaches 1.2550. You are in trouble now with an unrealized loss of 107+57+47=211 pips. 211 pips mean a straight loss of $2,110.

Some trades try to play martingale at this stage. Stubborn traders may be tempted to double up and bet on a decline. The stress level increases. You are tempted to simply stop the pain, get rid of it all and regroup. Now to simply get out will be your second wrong decision.

The pair EUR/USD is in a strong uptrend. It is set on going beyond 1.2550 level. The pair EUR/USD does not want to reverse any longer. Pride has no place in forex trading. The market proved you wrong and you need to move forward.

Do you know this fact that currency rates have a tendency to make a move, consolidate then continue? The one thing that can save you during this bad time is that currency rates do not move straight up or down. This stair case pattern is evident in most financial instruments. It simply indicates the accumulation/distribution stages of a move. The prices rises or falls then tries to consolidate before it rises or falls again.

These consolidation periods can be your savior. You should consider these consolidation periods as your window of opportunity. Longs may take some profits and the shorts may get stopped out and both need time to set new positions.

Wait for a dip to develop. It will definitely develop as the price cannot continue to rise forever. It has to consolidate at some level. That level can never be very far away. You look for a dip and a consolidation period to free up part of your position. You get rid of one lot at 1.2553 taking a realized loss of 107 pips. Taking a loss hurts but we have now given ourselves more flexibility and more margin. Now you have two lots short.

Range is when the market is consolidating. A range develops when both the support and resistance are horizontal. You wait for a range to develop. This soon takes place as a rough 100 pips range develops and trades for several days. You realize that a range has developed. You actively start to trade it with the third lot that you had freed from the trade.

You can cut your losses by trading the range that inevitably develops after each uptrend or a downtrend. This technique proves effective. You are nimble enough with intra day trades to quickly pocket a good amount of pips to offset some of the loss that you have taken by removing all the stop losses.

This way you can reduce your loss. The currency prices can never go up and up. It will at one point pause and try to consolidate. You have taken advantage of this fact. Lesson is to reduce your total exposure and try to manage it instead! Remember these simple steps to get out of a losing trade:

1) Unload part of your position on a dip.
2) Wait for a consolidation to take place and a range to form.
3) Trade the range with multiple quick ins and outs.
4) Minimize your losses and get out. Don’t try to convert your losers into winners.

But sometimes it is always good cut and run. You be the judge of your decisions.