How many times have you heard any of the following?
Trading is all about exits…
Timing your entries is always more important than your exits…
Each trade you consider, should have a minimum 2:1 reward to risk ratio.
You can’t make money if your risk is consistently larger than the profits you’re making.
The only way to make money trading is to have a defined system of trading rules and follow them.
Markets are constantly changing so trading rules should be seen as a guideline only.
Sound familiar? At first glance the above trading statements may appear contradictory, but actually, it is simply a matter of what trading model people have chosen to follow as to what mantra they choose to spout.
It could be argued there are really only two main ways people tend to trade, the traditional model and the scalping model, when looking at trading using these two models the above trading statements begin to make a little more sense.
The traditional approach looks for a minimum of 2:1 profit/loss ratio, it aims to make at least double what the risk is, it generally has fewer winners but the model attempts to ensure that they are large enough to pay for the losers.
The scalping model, on the other hand, does the exact opposite, it tries to make almost every trade a winner by aiming to achieve small but very achievable profits and avoids losses as much as possible by having wider stops, so when the stop loss does get hit, the loss is often much larger than the wins.
Just like the insurance business, the scalping model counts on regular winners and the occasional loss, in the same way an insurance company relies on regular premium payments to offset the occasional “claim” an insurance company receives as part of running its business.
If you are following the traditional model, each trade has the potential to be a large winner while your risk is generally small when you have a losing trade.
In order to follow the traditional model, it requires you to define your rules and have the discipline to follow them by taking each and every single trade.
Having the discipline to follow the systems signals are essential.
On the other hand, if you are trading the scalping model, skipping an occasional trade signal would mean almost nothing, in fact it may be an advantage for you to do so, as you might manage to dodge a large loss, which is the same thing as banking many winners.
So with the scalping model your discipline to follow the systems signals is actually less of an advantage and your discretion with the trades you choose to take becomes your key to your success.
The scenario above also goes a long way in explaining why exiting early using the scalping model is actually very smart.
With the scalping model you are trying to avoid losses, but your wins although small are practically guaranteed, so an early exit that avoids a major loss is often the right move for the scalping model.
But with the traditional model that relies on large profits when it gets it right, an early exit with a small profit could potentially be ruinous for the system, as it relies on large profits to recoup back prior losses.
Entry Signals & Risk:
When it comes to trade selection, traders using the traditional model can afford to be more relaxed about their entries as their risk is limited and the payoff from their winning trades is potentially quite large.
As a result traders using the traditional model need to be very disciplined with their exits as they rely on their winners pay for a larger number of losing trades the method usually generates.
Traders using the scalping model are just the opposite, they need to be extremely cautious with their entries, as their initial risk is alot larger than the traditional model.
They want to make sure the odds are firmly stacked in their favour before entering into a new trade, but are generally free to exit as they choose.
With the scalping model they are trying to avoid losses, but their wins although small are practically guaranteed.
Each trading model have their own characteristics and requirements, so before seeking anyone’s advice or take anyone’s criticism to seriously about what you’re trying to do with your own trading, make sure you first understand the strategy you are trying to implement and trade accordingly.
Reference Source: BK Forex – with thanks ( Abridged and reworded reference article )