Phil Seaton’s 7 Rules of Successful Financial Spread Betting
Here is the 7th and final part of my 7 rules of successful financial spread betting
7. Never add to losing trades
Seldom in trading is a mistake so expensive and as commonly made as this one. In fact most traders think it’s a good idea to add to a losing trade. Perish the thought. They think that if they take a second position they are averaging down their price. In rare cases this might actually work, but in most cases it will go against you and in fact creates a snowballing effect, whereas now instead of having a single small loss, you now have 2 losses. This is where you can get into real trouble and open a third and a fourth trade. Before long you have a huge position open which is way out of balance for your account and much too risky. These trades often go wrong and when they do they wipe out all of your trading capital. The right play here is that if you have a trade that has been going against you and it is clear that you are wrong on the trade, just get out of the market. This leads to taking the occasional small loss, but is not emotionally or financially damaging and leaves your trading capital intact for when the market is right and sets you up nicely to take advantage of the next big move in the market. You may often hear people talk about buying at a lower price if the market has gone against them, as it lowers their “average” price. This is total nonsense and is extremely risky. Not only that, but when you add to a trade that is going against you, you are going counter to the trend at that moment. It may well be that the trend has already reversed and by adding to losing trades you may end up with a large position against the trend.
The other side of adding to losing trades is a much more successful strategy of adding to winning trades. Several successful traders do add a second and a third unit to their trades. Personally, in my own testing I have found that a trader is better to concentrate on following their system on a single unit, rather than worry about adding to winning or losing trades.
Let me define trading units for clarity. Say that you are again trading Gold and you open your initial position at £10 per point. Let’s say that you bought Gold at 900 with stops at 800. If you were adding units you may decide that you will buy another full unit if gold moves to 910. This would mean buying another £10 per point, making your total bet size £20 per point. Then you would wait until 920 and add another unit and so on.
The problem with doing this is that it is great if this trade goes on to become a long trend. You will end up with a huge winner, but what often happens is that just as you complete pyramiding up of positions to say 4 units, the trend reverses and you end up taking an oversized loss.
The other issue is what to do with your stops? Do you, as you add units tighten the stops on the earlier units or do you leave them all at the original stop loss? There are drawbacks with both approaches. These are:
- You tighten your stops up on your earlier units so that all your stops are the same distance from the market as your latest and final unit. This often causes you to have your stops too close to the market and a correction can take you out of the trade when the trend is still valid.
- You leave all your stops at the same level as the original unit. Doing this means that you are therefore opening yourself to higher risk, as in our example you would now have £10 x 110 points exposure on your second unit instead of the original 100 points.
The other option is that you leave your stops at the same level, but reduce your bet size per point so that instead of £10 per point you cut back to £9 per point on the second unit. The problem with this approach is that you now have the same risk on the additional units, but because your bet size per point is now smaller, your profit potential is lower but you still have the same risk.
In back testing, none of these approaches are ideal and all of them have a destabilizing effect on the trading system. I have yet to find a way to get around this and end up with a trading system that produces higher returns but does not increase volatility.
The LS Trader system is a single trade unit system. The reason for this is that I found in my own testing that adding units to successful trades makes the system more volatile and increases the drawdown of a system. At the same time, the difference in profit per year is not improved sufficiently by adding units to offset the increased drawdowns.
Therefore, a trading system that adds to winning trades is not really that much more profitable and has larger drawdowns, but a system that adds to losing trades is deadly. Never fall in to the trap of adding to losing trades in the hope that the market will turn around and that you will benefit from a better average price.
Therefore it is better in my opinion to concentrate on sticking to your trading system with a single trading unit and not add to winning trades or losing trades. This will help you to consistently follow your trading system and in the long run should lead to better and more consistent results.
REMEMBER: NEVER ADD TO LOSING TRADES. LOSERS AVERAGE LOSERS.
I hope you have enjoyed reading these 7 rules. If you apply them consistently to your trading they will help you achieve better results. I will be posting regular articles on this site relating to online trading success. Be sure to check back often.
Good luck in your financial spread betting