How to exit a losing trade

Every few months, I get an email that goes something like this, “I’m holding a losing trade … it’s really hurting … I’m thousands of pounds down … how do I get out of it?”

It’s a situation that, to some degree or other, most of us have experienced at some time. The bad news is that it’s a scenario that has ended many trading careers far too early. The good news is that if you can live to fight another day – you’ve learned a very tough lesson, and can now move forward as a considerably wiser trader.

A trade that’s rapidly spirally out of control can leave us in a sense of panic – should we jump ship? Or should we hang on in and hope it turns around?

First question, of course, is “What the heck does your plan say?”

But, realize that the best made plans … and all that …

… and the last thing you need when you’re losing money is a lecture about trading with a plan!

Obviously, I don’t have a magic formula to make the market turn around and bring trades back into profit, but I can recommend the following 6-step program, which might just save your trading neck …

1 • Before we can find a solution, we need to look a bit more closely at the problem.

What’s causing this big loss? Are you trading with wide stop losses? Are you trading with big stakes? Are you trading with no stop loss? Is your trade hedged or not? Were you aware when you entered the trade that this was the risk level you were opening yourself up to? Or has this been a nasty surprise?

If you’re trading against (or without) a plan, jump to Step 3.

2 • Is this downside a legitimate part of your trading?

If you’re trading a longer term strategy, that waits for big market moves, then you must accept that there may also be big moves to the downside, too. If you’re happy that the logic that got you into the trade is still sound, and that you’re still away from your stop loss level, then ask yourself what’s stressing you out so much, and jump on to Step 4.

3 • Has a error been made?

Did you forget to use a stop level? Or enter the level or stake wrongly? Did you misinterpret the trading signal? Did you misunderstand the trade you were entering. If so, this position is an error and you should close out your trade immediately. It is a good idea to demo trade while you perfect your techniques before risking more money.

4 • Over-staking is a major cause of distress when a trade goes against us.

The recommendation is to risk 1–3% of your fund on any one trade. Yet many novice traders risk more than this, which causes them immense pain when a run of losses come together (as they tend to do). However, it’s also worth bearing in mind that even if you’re following the rules and risking just a couple of percentage points on a trade – a drawdown can still hurt. If you’re finding losses too painful, there’s no shame in further reducing your risk.

5 • If you think that you’ve been trading with too high a stake relative to your stop distance, then you’ll be over-exposed to the market.

This leaves you with two options: either close out your entire position for a loss; or close part of that position, leaving the rest with a chance to come good.

6 • Okay, so you’ve followed your trading rules to the letter … calculated your stake accurately … and this losing trade is all part of your strategy.

So why is this loss causing you such intense personal pain? This kind of stress can seriously hinder your decision-making. Your desire for the trade to “come good” can lead you to be overly optimistic about the chances of the market turning in your favour. This is not a good situation for trading. I recommend that you close out your positions, re-evaluate the trade with a fresh head on.

The crux is that an uncomfortable loss is caused by one (or more) of the following:

– not following a trading plan
– having a trading plan but taking too much risk
– underestimating how you’ll feel when your trade moves against you

Many traders will tell you that if the reasons you got into the trade are still valid, you should tough it out and wait for the trade to come good. However, I feel this logic ignores an important fact about human nature …

Human beings are hopeless optimists.

It may not feel like it, but world polls show that 95% of humans believe that their life in five years will be as good or better than five years ago. Just look at our blatant disregard for global warming – we just believe that it’ll be all right.

And that’s exactly what comes into play with losing trades, and why we have a tendency to stick with them for far too long.

Personally, I believe that pain level is a good judge. Even if your trade was good – if it’s causing you excessive pain – then you’ve risked too much. Reduce your exposure, check your staking levels, and then re-evaluate the market when you feel calmer.

Only you know where this pain level is, but I recommend that you listen to it, and learn where your limits are.

Related posts:

How to come back from four losing trades in a row This special stop loss will halt losing runs in their tracks