Elements of a Successful Trading Plan--Cut Losses Short

If you are following market trends rather than trying to anticipate
them, the next important part of the plan is how to exit trades that
don't work out. Here is where the second cardinal principle comes
in. It is Cut Losses Short.
This is another sensible-sounding concept that is much easier to
acknowledge than actually to execute when real money is on the
line. No one wants to exit a trade with a loss. They don't want to
lose money. More importantly, they don't want to admit they were
wrong. You can always think of many reasons to hold on to a losing
trade. You can hope that the market will suddenly turn around and
give you a profit instead of a loss.
This is another example where successful traders have learned to
do the hard thing. If there is one thing consistent in the stories of
how good traders turned themselves around from being bad traders,
it is their attitude about losses. Professional traders accept that
losses are part of the game. Since the markets are mostly random,
the best trading methods will always have numerous losses.
Professionals do not equate losses with being wrong.
It is precisely because correct trading methods invariably generate
many losses that it is important to keep the individual losses small in
relation to the overall size of the account. In order to keep trading,
you must preserve your capital. If you can keep trading in the
direction of the trend, the big profits will come. However, if you take
too many large losses, your capital will be wiped out before you can
enjoy the big profitable trades.
The laws of probability insure that regardless of your approach, you
will inevitably suffer some long strings of consecutive losses. If you

are risking too high a percentage of your account on each trade,
before long one of these unavoidable losing streaks will blow you
away. Keeping losses to about one percent of your account size is
optimal. With smaller accounts, the percentage will have to be
larger. Five percent on one trade is probably the highest prudent
level of risk.
Because of the randomness in commodity price action, you must
allow the market a certain amount of leeway before giving up on a
trade. In general, you must be willing to risk between $500 and
$1,000 to trade most markets. For smaller accounts, the Mid
America Exchange offers trading with smaller sized contracts that
allow you to trade with lower risk.
While there are more sophisticated ways to decide when to exit a
losing trade, getting out after a loss of a predetermined dollar
amount is as good a way as any. The important thing is to respect
your plan. You can place a stop-loss order with your broker that
instructs him in advance to exit a trade if the market hits your loss
limit. You should always do this to guard against inattention or
changing your mind at the crucial moment.