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TradingDay.com > Technical Analysis Tutorial

T e c h n i c a l   A n a l y s i s   T u t o r i a l
by Alan Farley

Cutting Losses

What elements of the trading game do you concentrate on each market day? Do you push hard for the big gain but face big losses when the action suddenly turns on you? Or do you slowly build up each profit and always watch defensively for a quick exit when wrong? The path you take will define your success or failure as a trader.

Our online trading course MASTERING THE TRADE uses the simplified table just below to illustrate a few important observations about profit and loss. Most trading strategies have a built-in success/failure rate. For example, scalping incurs a high %WIN but a low AvgWIN. Alternatively, buying breakouts reflects a lower percentage of winners but the average gain is greater. Regardless of how you trade, the market offers only three ways to improve profitability (for any given number of trades):

- Raise your %WIN
- Raise your AvgWIN
- Lower your AvgLOSS

Day traders have fewer profitability options than position traders. Price tends to move away from an entry point as a function of time. So individual day trading gains (AvgWIN) are generally smaller than position trading gains. Very short-term time frames also frustrate attempts to raise %WIN since day traders must be right immediately while a position trader can wade through many whipsaws to get to a profit.

But day traders are in a much better position to control losses than position traders. The price-time tendency now works to their advantage. In other words, incurred losses should be smaller (on average) because the position is held a shorter period of time. This allows day traders to take their individual losses closer to -0- than position traders.

Manage the loss side of trades and you'll increase profits more quickly than chasing gains. In preparing your exit, recall a valuable rule for optimal technical analysis entry: execute your trade where price must move only a short distance to prove that you are wrong. This frequently defines a strategy where you enter a promising position right at support/resistance. If price goes through the line, exit immediately with a small loss and get on to the next trade.

You have to be very, very good before you allow yourself to be bad. %WIN simply measures your winners against losers. If you make money on 3 out of 4 trades, your %WIN is 75%. See how the average loss changes from the 75% to 25% levels.
AMZN's daily range expands over a 3-day holding period. This tendency of price to move away from an entry point underscores a natural advantage the day trader has over the position trader or investor. The shorter a position is held, the more efficiently losses can be taken. Day traders must capitalize on this mechanism through quick exits on non-performing entries.
 


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