Initiating a position and then watching the market immediately move in your favor can be very exhilarating. Just because the market is going your way, however, doesn’t mean there isn’t work to be done.
Quite the contrary. Once you are in a winning trade, the first thing you need to do is reexamine your risk and stop placement.
Trading is a game of odds and a game of managing risk. In fact, even a less than stellar trader has the potential to be profitable if he or she does a good job managing their risk. Some would argue that risk management is the single most important factor when it comes to profitable trading. We happen to agree.
Suppose that you are looking to buy 100 shares of stock ABC on a dip and that the stock is currently in the midst of a strong uptrend. With the shares currently trading at $50, you place an order to buy at $48.50 and place a stop-loss order at $48.
Two days later, your order to buy at $48.50 is filled, and the stock immediately reverses course and starts heading higher. By the market close that day, the stock has risen back to $49.10 per share.
The first thing you should do is consider your risk.
Because your initial risk on the trade was $.50, you could now move your stop up $.50 to the breakeven level. If the stock is unable to resume the uptrend and rolls back over, you may get stopped out with a breakeven trade. No harm done except transaction costs.
You can also look to move your stop up in smaller increments. For example, for every $.50 the stock moves higher, you could move your stop up by $.10. Whatever the increment is, you are still cutting your risk on the position as it moves in your favor.
In addition, once the shares have moved significantly higher from your entry price, you could look to not only put a stop at scratch, but you could consider trailing the stop to lock in profits as the market moves.
RISK, RISK, RISK. It’s all about risk.
Approach trading with the mindset of focusing on how much you can lose on a given trade rather than how much you can potentially make. Doing so may help keep your risk management focused and objective and could help keep you in the game.
