Managing Winning Counter-Trend Trades
Monday we outlined our bullish thesis toward Indian equities and provided a number of counter-trend and breakout trades for our subscribers, many of which began to work right away and are now sitting between their risk management level and upside price objectives. So the challenge now becomes, how can we manage these trades so that we give them enough room to work, but also don't allow them to turn into losers if they should reverse from current levels.
The first and most important step is to make sure your position is sized correctly for your risk profile and market approach. If you're trading too big, you're more likely to make decisions based on emotion rather than your process. Additionally, if the position turns against you then you may sustain a significant drawdown or be knocked out of the game entirely. Capital preservation is just as (if not more) important than capital appreciation because you can't play without having any chips to bet with.
So if your position is too big (even if the trade is working), do yourself a favor and scale it down to the appropriate size. Even if it works once or a few times, a lack of adherence to your risk management process will always come back to hurt you in the end.
Before we get into a winning trade, I want to provide an example of a losing trade. It's the exact same setup as I'll talk about below (failed breakdown and bullish momentum divergence), but it had no upside follow-through. Prices were back above former support for three days and quickly reversed. Will it eventually work? Who knows, that's not our problem. Our original thesis was to only be long if prices were above that former support level and they're not, so we take the loss and move on.
Depending on our exact entry into the losing trade, some of the methods discussed below could've helped reduce our risk and limit our losses once we the trade ultimately confirmed it wasn't working. So keep that in mind as we walk through this next example.
Now onto managing a winning trade. Let's use the example of VRL Logistics. Prices broke below former long-term support, momentum diverged, and prices based tightly before finally confirming a failed breakdown. This defined our risk at 259.50 and gave us an upside target near 310.
Click on chart to enlarge view.
The stock immediately started to move and is now sitting near 274, roughly 15 points above our risk management level and 36 points below our upside objective. While we want to give it room to run, we don't want to allow this to turn on us...especially in the current environment.
So we have a few options.
The first option in trades like this that start to work immediately is to "feed the ducks." This refers to taking profits on enough of the position so that if your original stop is hit, the initial profit taking offsets any losses. It essentially becomes a risk-free trade.
Another option is to use something like a trailing stop or volatility-based stop that takes you out of a position when the trend you're looking to capture is no longer intact or if volatility expands to a level that you're no longer comfortable with.
A third choice is to use a time-based stop, given that these types of trades tend to work best when there's fast upside follow-through after it confirms.
Regardless of whether you choose one of these methods, something else, or a combination of a few, the underlying message is clear. It's just as important to manage your risk when you're right as it is when you're wrong, especially when trading against the primary trend.
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Allstarcharts Team