The Perpetual Motion Machine – Knowing when to stop.

As some who worked in the field of machinery diagnostics, I was often asked to give my opinion on the timeliness of a machine’s maintenance and when to take a machine off line if it wasn’t performing properly.

This was done to make it possible to do the necessary maintenance on the machine, replace worn parts, lubricate and align the machine. The machine was then tested before applying the power and putting it back on line, where the consequences of failure can be very high.

When working with traders who are having difficulty with their trading, one of the first questions I ask is; “Where in your trading plan does it say when you should stop trading”?

Most traders don’t have conditions set down to identify when they should stop trading.

This represents a big problem. Their plan (if they have one) states, or at least implies, that they should keep trading forever, without reference to losses or profits or other (changing) conditions. It doesn’t matter how bad their results might be, if their plan assumes or tells them to keep going.

Those same traders would take their car to a mechanic immediately if it started making a horrible noise. Yet when their trading balance is being hammered they don’t stop trading to figure out what is going wrong.

A trader once told the author:

“I started with $250K, I’m down to $50K and I’m going to keep on investing till it’s all gone.”

If a trader is unable to stop trading, it normally happens for one of several reasons. The most common is that they are addicted to the excitement and the emotional rollercoaster of trading and losing.

Alternatively, they are so attached to the goal of becoming a trader that they don’t know when to stop trading when they are executing their plan well.

Frenetic activity isn’t necessarily progress.

In contrast, expert traders know when to stop trading and when they need to step out of the market. They don’t feel compelled to be trading at all times. They know when they are most effective and when the risk present in the market is not acceptable to them.

How to use this information

A well formed plan should have exit criteria and contingencies built into it. An essential part to any trading should be conditions for stopping trading.

Possible criteria for stopping trading are:

  • A set number of losing trades in a row.
  • A major drawdown on your trading balance to a set percentage.
  • A major change in the market that represents excessive risk.
  • The market conditions do not support your trading style.
  • Something in your life is stressing you and you are unable to make clear decisions.
  • You feel you are unable to trade well.

All of these things should be possible exit criteria for stopping trading until you feel you are able to trade effectively.

Once you take time out, your re-entry to the market should be dictated by the market conditions being supportive of your trading style, the work you did when you weren’t active in the market and the risk profile you have chosen.

This and other topic relating to trading plans are covered in the Clear Mind Trading Course. For more information go to http://www.tradingstate.com.au