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Right now, new traders are finding out the hard way how challenging it is to navigate a headline-driven market.
A promising position can suddenly reverse due to unexpected news, turning a winning trade into a loser.
Even if you do get the direction right, it’s hard to know when to take profits when news can break at any moment.
Worse, it’s hard to discern if any of the headlines are even real. The last thing you want is to enter a trade based on a fake story, only for it to quickly unravel.
So let’s explore some key principles that will help you trade in these conditions…
When traders look at an emerging trade setup, they typically focus on potential profits. Then they work backwards to identify their maximum tolerable loss. That’s where they place their stop loss.
The goal is to find the optimal relationship between risk and reward.
But in a highly volatile market, you’ve got to flip this concept on its head. You need to put risk management first and clearly define your trade boundaries before thinking about how much you could make.
Rather than choosing a fixed percentage or dollar stop loss (as you might in a more orderly market), you want to identify which price level would invalidate your trade. For instance, if you believe a stock is about to pull back, how much further would it have to rise for you to reevaluate? Then, if the price hits that level, you should exit your position immediately.
Hanging on in the hope that the trade might turn around is not a strategy.
Likewise, in a less volatile market, it can be appropriate to set a fixed profit target. But when markets are moving around all over the place, this goes out the window.
You need to identify when the move is fading and bank your profits immediately. So, for example, if you buy into a move and momentum falters, you should exit your position – even if that profit was less than you’d expected.
Similarly, you want to adjust the time horizon for your trades…
One of the more frustrating things is getting a trade’s direction right but watching it turn into a loser. It’s enough to pull your hair out…
You can get caught like this whenever you start hanging on to winners to give them a shot at bigger profits.
But in markets like this, you need to shorten your trade time. You need to assume that moves will happen faster, fade just as quickly, and reverse harder than you’re expecting.
So you should never be afraid to bank a gain, even if it’s small. If the gain comes quicker than expected, even better.
The key is to stay nimble and flexible and not locked into any view. In markets like this, not taking a big hit is more important than trying to squeeze every last dollar out of a trade.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
