1. Cut loss
Cut loss will be done by immediately closing the transaction in order to avoid the potential greater risk. The following illustrative examples may help you to grasp:
For example, when we predict the price will fall and conduct transactions SELL as much as 1 lot at level 1.5020. Apparently, in the middle of the movement the prices are moving up to level 1.5050 , we bear a loss of -300 pips. We don’t want to fall on a greater risk of loss, thereupon at the level 1.5050 you should immediately closing the SELL position. The consequences is we suffered a loss of -300 pips.
The objective is to dispose of loss position and not to let those becomes much larger, and then to cover with a new open transaction in opposite way with the early transaction. Usually it done for the conditions when the relatively price in a moves tight.
View the following illustration:
For example, we open a SELL position at level 1.5020 , on the contrary the price moves up and reach at level 1.5050, we’re already bear a loss of -30 pips. If we assume that price movements are still going to rise, later at the level 1.5050 we close our SELL position earlier. At the same time, we also open BUY positions at the 1.5050 level.
If you find that prices increased up to level 1.5080, the pervious BUY position we had been opened is going to get a profit of +30 pips. That is, losses -30 pips of SELL position had been covered.
New switching might be allowed if we really believe that prices will continue the direction of movement. Because, by doing the switching means we’ll open a new position which of course, has the potential for loss as well if the prices direction reversed again. Here the necessary full-fledged, prepared, and readiness level of mental analysis for a trader.
Averaging (cost averaging) is an extreme form of risk management because basically this technique is “against” the direction of price movement. This technique can only be made for traders who have large sums of money and having a stable frame of mind.
See examples as follows:
Suppose that we are SELL 1 lot at level 1.5000. When the price moves up or down to the level 1.5050, we are not closing the early loss position, but we add another 1 lot SELL position. At this level, our l osses have reached -500 pips.
Apparently, the price rises again up to the level 1.5100. At this level, we’ve become a loss total -150 pips. Our losses will closed if the price falls back to the level 1.5050. If at this level we close all our SELL position, then our losses will be zero.
If the price falls back to the 1.5000 level, then we will get a profit of +150 pips. This technique is only well-turned if we use in a sideway market situation, because the opportunity for price back to our starting position is have a larger possibility.
This averaging technique has some development that can be adjusted to the resilience of our capital, so it is often also referred to as the “capital management”.
Some people called it “locking”. Actually, this is a bizarre technique, because when the traders are fall on actual losses, we can’t do anything with losses that we’ve already suffered.
It is not recommended for you to doing this. The only reason why this technique being explained is to let you know that there are some traders who us ing this technique occasionally.
Here’s fot the example:
When a trader SELL 1 lot at level 1.5000, he will experience -50 pips of loss if the price rises to the level 1.5050. (Remember, he had loss in previous place!)
However, he didn’t want to “throw away” the losses position. He actually BUY 1 Lot at price 1.5050. Well, at this time the trader “locked” his -50 pips of loss. Later on wherever the price moves afterwards, he only suffered losses amounted as big as the “locked” costs.
Obviously these traders have suffered losses. There’s no difference by doing cut loss, It merely there is no position closed yet.
When the price rises to 1.5100, traders should closed his earlier BUY positions on the price of 1.5050. Although this BUY positions +50 pips profit, but do not forget the SELL position remains on the bottom (which is currently the loss of -100 pips!). Therefore, our traders are still suffering a loss -50 pips.
The trader’s losses will be covered if the price moves down to the level 1.5050, if at this price he closed the SELL position for the first time (at the price of 1.5000). +50 Pips profit will be obtained if the price falls down to the level 1.5000.
This is the most “justification” and oftenly used as an excuse by the perpetrators of locking. In fact if you want to see more details, there is no different than doing cut loss at 1.5050 price and then commit another SELL at 1.5100 price. Try calculate it and figure!
In determining the level of entry (buy or sell) and cut loss level, switching, and so forth, we can combine it with technical analysis, we know.