The Importance of Take-Profit and Stop-Loss Orders/Decisions (Including Trailing Stops) When Trading Chinese Assets

The number one message we are trying to get across through this article revolves around the importance of… well, actually having an exit strategy, with all that entails. This goal may seem blatantly obvious but in reality, the overwhelming majority of traders don’t actually have a meaningful exit strategy and choose to play it by the ear, including many of those who roll their eyes when reading posts such as ours.

To take things to a more granular level and explain what we mean when it comes to the term “playing it by the ear”, we want to make it clear that the time to think about your exit is well before even initiating a trade. Some market participants may find this approach peculiar, in light of the fact that exit decisions are price action-dependent, so why bother thinking about your exit right from the beginning when you can simply let prices dictate what the best course of action is?

The answer revolves primarily about emotion control.

Yes, it is correct that nobody can predict the future and that a wide range of developing factors will end up influencing your decision with respect to exiting a trade, but who exactly says that you have to come up with just one scenario?

Instead, the name of the game is thinking about more than a few possibilities as well as outlining at the very least a baseline strategy involving the best course of action in the cases in question.

Why do it right from the beginning?

For the simple reason that you have the luxury of time and thinking with a clear head on your side.

Of course, it is your prerogative to let’s say live dangerously and go with the flow, choosing to react to events rather than try to think about them ahead of time. But do you have that much confidence in your ability to perform well under pressure?

Even the best of traders have to undergo psychologically tormenting periods of being underwater and, make no mistake: fortunes have been lost due to the emotional dimension time and time again, even among legendary traders, for the simple reason that Average Joe traders as well as legendary traders are… well, human.

Do you believe you’ll make stellar decisions while let’s say underwater and under a great deal of stress?

If so, you can go ahead and stop reading.

Realistically speaking, however, the overwhelming majority of traders who believe that are deluding themselves and it is usually only a matter of time until strategy-altering amounts of money are lost, for reasons such as:

1. Doubling down instead of exiting due to an unwillingness to accept that you were “wrong” or if you will, that the market decided to do the opposite of what you thought it would do. In such cases, a stop-loss order (instructing your broker that when the price hits $, it is time to sell) or a trailing stop (a stop which follows the price, for example instructing your broker to sell if the price collapses by 10%; should the price do the exact opposite, your trailing stop will follow it higher) would have been life savers
2. Revenge trading or, in other words, taking on trades not because your model tells you they put a risk to reward ratio that is asymmetrically in your favor on the table but rather because you are angry and want to somehow “punish” the market. Unfortunately, it’s not the market that usually ends up being punished
3. Getting married to a position, in other words not necessarily doubling down all the way but at least adding more margin for emotional rather than pragmatic reasons
4. Becoming greedy and chasing winners far too aggressively, to the point of perhaps seeing all profits wiped out by something along the lines of a flash crash. Needless to say, the idea of using take-profit orders to… well, take profits when the right conditions present themselves would/should have been a no-brainer
5. Going the Martingale route or, in other words, risking more and more capital so as to “get your money back” instead of simply letting your money management strategy run its course

The list of reasons is miles long, with these five representing only a few of the most obvious examples, and the bottom line being this: stop-loss and take-profit orders are perhaps more so than anything else, here to protect you against yourself. Not because you are somehow an “inferior” human being who is incapable of rational decision-making but rather because you are just human (without the “inferior” dimension) and these order types enable you to essentially put your seat belt on before entering a trade.

Do these principles apply for absolutely everyone?

Of course not, there is no such thing as a “one size fits all” approach when trading Chinese assets or anything else for that matter.

You may very well be the exception in this equation, a trader who thrives under emotional duress. But words cannot begin to describe how unlikely this is and the ChinaFund.com team cannot make strategy-related recommendations based on outliers. On the contrary, we put ourselves in the position of the average trader and understand that as it is, the odds of doing well by trading rather than accumulating (a topic we have dedicated an article to) are strongly against you. Add an emotional dimension that isn’t kept in check to the equation and you have a potential perfect storm brewing, one that can and eventually most likely will wipe out even a seemingly robust portfolio.

“Wisdom” is the operative word if you are serious about standing a chance and, of course, ours is for hire should you be interested in leveraging our expertise when it comes to Chinese assets in particular and financial markets in general.