Regardless of what type of trading context you are considering, losing is just another part of any form of financial trading. Every trader has a bad day regardless of how skilful they are. In fact, the best any person can hope for is a 60/40 ratio in the wins and losses a trader can experience in the market. As losing is something that cannot be avoided the best any trader can do is to be prepared for these loses and have strategies to manage their trades that they are about to lose.
Potential Issues in Manage Losing Trades
Before going deep into how to manage losing trades, it is important to understand some of the common mistakes traders make which lead them to losing their trades. One of the greatest among those mistakes is a loss of trading discipline. Whenever an investor allows emotions to affect their decision making capacity, they lose the trading discipline. This could include anything between greed, fear, frustration or anything else that can hinder the trader's capacity of decision making.
The next issue that could lead to a losing trade is a faulty trading plan. It is always very important to make sure that you are working with a well-documented plan that accounts for risk management and specifies good estimates on the return on investment. This in itself can help avoid most of the trading pitfalls in any scenario. However, regardless of how much you plan, the markets are always unpredictable. As a result, it is very important to adapt and modify your trading plans according to the situation. Similarly, some other factors that can lead to losing trades include poor risk and money management, having unrealistic expectations from the market and so on.
Averaging is one of method many traders use to manage their trading losses effectively. In this, the trader is adding money to a position after the market has started moving in the opposite direction. While this strategy has the advantage of helping improve your average price, there are some issues that need to be addressed first before using this strategy. There is always a fact that the market's momentum is always against you when you are using the averaging down strategy. This only means that you would be essentially adding to a losing trade and this practice can be very bad for your trading account if you fail to assess the market's momentum accurately.
It is also quite possible to easily understand when a trader is averaging down for wrong reasons. All you need to do is check for the validity of the rationale behind the trade. If you find that the rationale is invalid, there is no reason for you to be involved in the trade. If the rationale for the trade is invalid and if you are continuing to average down, you are getting involved in the trade for wrong reasons and hoping that the prices will move towards the target you desire. This is an approach that should be avoided at all costs in trading.
Managing the leverage
The next most useful method most investors use to manage losing trades is by using leverage. This provides the traders with an additional opportunity to improve their returns. However, you need to know that leverage can at times be like a double edged sword that could amplify the downside as much as it can boost your gains. The markets usually allow the traders to leverage as much as 400:1, giving them a chance for massive gains while at the same time crippling losses too. Even though the markets allow the traders to invest in massive amounts of financial risks, it is generally advisable to limit the amount of leverage used.
Most of the traders generally use a leverage of 2:1. The amount of the leverage that is available comes from the margin that each broker is required to place for each trade. The reason why a trader may fail in this scenario is because of being under-capitalized in comparison with the trades that they may have placed. Leverage not only magnifies losses but can also increase the transaction cost and these costs continue to increase as the value of the account drop.