Today the Trader's Blog is welcoming back Marc Nicolas of TradingEmini.com. In previous posts Marc has shared invaluable trading concepts as well as tips on technical analysis. Today will be no different as he discusses the concept of using a runner to break up lots and control risk. If you like this post be sure to join Marc and the TradingEmini.com staff for a special webinar for INO users next Wednesday, click here for more information.
To make serious money trading while controlling your risk, you need to master “the runner.” The runner is the percentage of a position which you keep open for as long as possible when the trade moves in your direction. It’s one pillar of the fundamental trading maxim, “cut losses fast, let profits run.” Sounds easy, however applying the runner principle is challenging. To understand why, we’ll look at how the most minimalist trade, buying one contract or share, can be sub-optimal.
Typically, when a one lot trade moves in a traders direction, they are eager to pat themselves on the back, so exit and bank a small profit as quickly as possible. Often traders will then suffer mentally as the market continues to move in their original direction. Annoyed by the missed profit, after a short but lethal delay, just when the market is about to pullback a little, they will enter again, only to be stopped out, returning their banked profit from their first trade (one lot).
In this situation, an extremely disciplined trader, with a low daily target, will turn off their computer after that small winner on their first trade. They are a better trader than the one above, keeping greed in check, but they are still behaving sub-optimally as they are loosing out on the bigger move days which could drastically increase their annual returns.
The first solution is to use multiple lots, shares or contracts. However, if you are still entering all in, exiting all out, and scalping profits on small moves, you are taking high risk to profit ratio trades which will eventually eat into you capital unless you have a very high percentage of winning trades. (Note: when you enter a trade with multiples, your risk should not exceed 1% of your capital – see why in one of our previous articles, 9 Key Trading Concepts).
The next solution is too use multiple lots but scale out. So say you enter with 2 contracts, with a 1.5 point stoploss. As the market moves in your direction, you can exit 1 contract at 1.5 points. Immediately you have satisfied the emotional need to take profits and your risk is eliminated, because if you don’t move your stoploss and the market turns against you, your overall trade will be breakeven. Alternatively you can play it tighter and move your stop to breakeven and protect your banked profit of 1.5 points. Either way you can trade your remaining contract, the runner, in a more technical, less emotional manner because you have put yourself in a position to capitalize on a bigger move on an auto trade with your runner protected by your exit on the first contract.
The challenge is holding onto that runner. And you should because 1 risk free runner is worth a lot more than repeated full risk scalps. For instance, assume there are 9 points between a support and resistance area and you take 2 trades for the day, 1 winner, 1 looser, using 2 contracts with a 1.5 point stop loss.
Lets look at two scenarios, one with a scalping style and one using a runner, in exactly the same market circumstances.
Scenario One – Scalping with Fear
On the first trade the market moves 1.5 points against you, so that’s a 3 point hit to your account because you are using 2 contracts.
Because their account is negative, typically newbies now start to “trade their account” i.e. they just want to get breakeven and don’t focus on their charts. So on the second trade the market moves 1.5 points in their direction. They scalp out both contracts at 1.5 points, that’s 3 points profit, bringing their account to breakeven for the day and they sit frustrated on the sideline as the market continues to move in their direction.
Scenario Two – Using a Runner
Your first trade is exactly the same as above, market moves 1.5 points against you, a 3 point hit for 2 contracts.
However this time, on the second trade, you trade like a pro, focusing on your process, your next trade, not obsessed with your P&L. So you exit the first contract at 1 point profit and keep the second contract, the runner, for two thirds of the 9 point range (between your support and resistance), exiting at +6 points, making your account 4 points profit for the day (1st trade, -3, 2nd trade-contract#1, +1, 2nd trade-contract#2, +6 = +4).
To match the performance of the trader using runners, the scalping trader would have to continue trading, racking up commissions, and risking digging themselves into a hole which gets worse as their emotions begin to drive their trades.
Finally there are several ways to determine when to exit your runners. You can either use your technical analysis, be it the next resistance, support level determined by Fibonacci, price action, moving averages, floor pivots, oscillators, whatever works for you OR by using a trailing stop. It’s a matter of personal choice. I prefer to rely on my targets, and see if momentum begins to shift at our support/resistance. Either way, hang onto those runners until your teeth hurt, knowing that you are in a risk free trade which is better than having to potentially enter the market several more times at full financial and emotional risk. It’s when you grasp and apply the runner concept you will transform from a good to great trader.
For more from Marc and TradingEmini.com be sure to visit their free webinar for INO readers, Wednesday August 25 2010 at 4.00PM EST, click here for more information.