How many investors have experienced a profitable trade turning into a stop loss disaster? Or, on the other hand, a trade that went bad from the beginning and then got stopped out exactly when the market reached a key reversal point?
These occurrences cannot be fully avoided, but it is possible to reduce their frequency by better managing your trading positions.
Technical and Fundamental Analysis
Let’s start at the beginning. Before you open your financial spread betting position, it’s important to document the current situation, from both a technical and fundamental perspective.Initially this means marking the price at which the trade would be executed. According to the horizon of your trade, be it hours, days or weeks, capture the current level of key indicators such as the 20, 40 and 89 exponential moving averages.
You should also mark the first and second support and resistance lines and record the level of key indicators such as the Moving Average Convergence/Divergence (MACD), stochastics and Relative Strength Index (RSI). If you are proficient in channel plotting then that could also be of use.
In contrast to this technical analysis, fundamental analysis attempts to capture the current sentiment in the market.
It is important to be aware of the general price direction, what fundamental information is driving the price and what the up-coming expectations or events are. The common tools for this are daily market news and economic calendars, especially the detailed ones that offer some market commentary as well.
Charts and Timescales
Arguably, even before you get to the stage of technical and fundamental analysis, there are two questions every investor should consider:- Which time frames to trade over? Do you want to hold positions for a few minutes, hours, days or even months?
- Considering which time frames you decide to trade over, which spread trading charts are most likely to aid your trading decisions?
- Very short term traders often make use of 1, 5, and 15 minute charts
- Day traders typically make use of 5, 15, and 60 minute charts
- Swing traders frequently make use of 1 hour, 4 hour and daily charts
- Longer term investors often look at 4 hourly, daily and weekly charts
The longest is used for market perspective and the ‘long’ term trend, the middle is the one upon which you would decide the direction of your trade and the last is merely to optimise the timing your entry into the market.
Let’s assume you have a long position open with a day trader’s perspective and so you are looking at the hourly chart. It’s important to watch out for key signs such as the market moving closer to support or resistance; price action can be erratic around these levels.
Investors should also watch the main overlays for any kind of moving average cross over (MACD) as indicators such as this can provide a lot of information. For example, if the 20 point Moving Average (MA20) line crosses under the MA40, it may indicate a trend reversal.
Typically, if you’re trading a long position you should expect the MACD line to positively diverge from its signal line, although you should be careful of ‘fake’ crosses. On the other hand, a negative divergence should alert you to a possible reversal.
Indicators and signals do not always indicate a full trend reversal, as there may simply be a correction or a market breather, however, you must be alert and vigilant when they occur.
Planning Your Exit
One of the last things to do before opening a trade is to consider the different courses of action, both for better and for worse, of where, when and how to make your exit from the position.Just like entering your trade, the reasons for exiting, and the movements that prompt you to do so, can be both technical and fundamental.
A good example for a technically influenced exit would be a breakout or a breakdown of the current trading channel, or a high-probability reversal pattern such as a ‘head and shoulders’ formation.
An example of a fundamental reason to close a trade would be to re-evaluate the trade when a GDP, unemployment, or a relevant interest rate announcement is expected.
Fear, Greed and Stop Losses
So far, so good.What’s harder than planning your entry and exit into a trade is managing yourself when there is money on the table. It can be very hard not to give in to one of the two most basic emotions: fear and greed.
Fear will appear whenever the market is trading against you, either creating a loss or eating into unrealised profit. At this point, it’s critical to make an effort to stay rational and analyse the situation.
Check: has something materially changed from a technical or fundamental perspective since the position was opened? If the answer is no, then you must be strong and stick with the plan.
On the other hand when profits are running and you have reached your pre-determined target, unless something again has materially changed, you should close your position. If you do not then at some point, perhaps not this time but some time soon, you are likely to lose out to your greed.
The other more dangerous manifestation of greed is actually when a trade is going badly and, as the market nears your stop loss, you decide to extend the stop. In most cases this will just make you lose more money; do not fall into this trap. It’s much more likely that your original analysis, made before there was money on the table, is still accurate.
Hedging Positions
Another, more proactive, way of managing a trade is hedging.Just to be clear, opening an opposite position on the exact same instrument is NOT hedging: it’s a waste of money.
Hedging is when a position is established in one market in an attempt to offset exposure to price fluctuations in some opposite position in another market. The ultimate goal is to minimise your exposure to unwanted risk.
Therefore, if you want to use hedging as a strategy, which is an advanced method of managing risk on your open positions, you need to do it on a different market.
For example, let’s assume your 3-6 month medium term perspective on the EUR/USD foreign exchange rate is bearish. As a result, it would make sense to sell the December Futures Contract.
It might be that, while this position is running, your shorter term analysis is indicating a bullish correction. At this point you can either use the October Futures Contract or the Spot Contract to hedge your position. This can be a ‘perfect-hedge’, ‘partial-hedge’ or even an ‘over-hedge’.
Another more advanced technique for hedging would be to use Out Of Money (OTM) options. However, this requires a much more detailed analysis and a whole new level of complexity is introduced when trading options.
Spread Betting and Trading Sessions
Another consideration is the nature of the trading session itself.In the UK we have three major trading sessions in the day: Asian, European and American, though some overlap with the others. Some traders prefer to close their position when the underlying market session is over, while others are happy to keep their positions open overnight.
If you decide to keep a position open outside market hours, or just let them run while you sleep, it is highly recommended to take protective measures before signing off. A lot can happen while you sleep, therefore revaluate your stop loss order and consider adding a limit if you don’t already have one.
Some spread betting companies like InterTrader allow you to speculate on a number of key markets 24 hours a day from Sunday night to the market close on Friday. This can be particularly useful for investors who want to trade out of market hours.
Managing your positions is a serious and complex craft which can have a significant impact on your trading results. It all starts by making a well-informed decision and documenting the relevant information. This is followed by building a rigorous regime with a central message: stick to your plan.
Spread betting and CFD trading carry a high level of risk to your capital and you may lose more than your initial investment. Spread betting and CFD trading may not be suitable for all investors. Only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved and seek independent financial advice where necessary.