No trader wants to see his/her positions being liquidated. The feeling of an account shrinking from $5,000 to $1,000 will never be pleasant.
At the same time, getting liquidated is often part of a trader's life - nearly all traders have experienced the pain of being liquidated at least once in their careers - and can even be a chance to learn from your mistakes and lay the basis for improvement.
So what should you do when that happens? Are you even prepare for that event to occur?
Justin Bennett, a world-famous foreign exchange master with more than 10 years of experience, has some relevant advice on this topic.
Take a break
There are two types of traders. One is the trader who takes a break after a bad run. The other is the trader who immediately tries to recover losses - and often falls prey to emotions, with a real risk of doubling down on poor results.
Taking a break gives you time to clear your head and concentrate on solving the underlying problems that led to being liquidated.
How long one should stay on "sabbatical" varies from person to person, but generally speaking, it is recommended that no less than a week should be trading-free.
Review your transaction logs
After a period of time without exposure to the market, you should work on diagnosing what got you in trouble and where possible start to plot a different course of action. Since trading is a complex endeavor and there is a series of interconnected factors affecting your performance, you might start with doing the following:
1. Choose a higher time frame
If you typically trade on 5- and 15-minute charts, shifting to a longer time frame - let us say the 4-hours and daily ones - can make a big difference. This in turn will provide some fresh air and may help you improve your performance.
(Notice that although relying on shorter time frames can certainly be profitable, most traders tend to improve their performance as they shift to higher ones)
If you always use a shorter time frame for trading, you can try another time frame. Stick to the daily chart for at least 60 days to see if your trading results improve!
2. Reduce the frequency of your transactions
Like time frames, your trading frequency can have a huge impact on performance. Remember, in trading, less can be more if you focus on quality rather than quantity.
If you trade 15 or more than 20 transactions per month before, try to reduce it to 5 to 10 transactions when you get back to your desk. If you traded 10 transactions per week before the liquidation, try to trade 5 or less per week.
3. Reassess you Risk-Reward Ratio
The Risk-Reward Ratio (RRR) represents the amount of capital you are willing to lose in a trade compared with the expected gain that trade could bring. It is often said that the RRR should be stacked in favor of profit, which is to say that for every position you take, you should be aiming to make more than you may lose.
For example, if your goal is taking profit at 10%, but your stop-loss is set at 20% from the entry point, this is not a good bet.
Sticking to a good RRR requires patience and some nerve. Many traders tend to take profits too early. Some do so out of design, others due to fear of losing the profits they have already accumulated or cutting the loss they are incurring in.
But regardless of their reasons, using negative risk-reward ratios makes liquidation more likely.
Cut your numbers down
The worst thing to do after a crisis is choosing to expand the transaction size in the hope of regaining the lost capital. On the contrary, it may be a good idea to reduce the transaction size across the board, for instance by reducing your risk by half.
Finally, consider transferring part of your funds. The funds in the trading account are risk capital that you are liable to losing - using a smaller amount will help reduce your stress level and will ultimately lead to better trading results.
At the end of the day, after a liquidation, you may want to reduce the size of your trading account, the risk associated with single transactions, and the frequency of your trading.
Test your skills with either a demo account or a small real account
As you move back into trading, you have to decide whether to rely on a demo account to test out new strategies or use a real one to trade again.
Ideally, a demo account would allow you to figure out your next moves with zero risks - and so it should be the default solution. But some traders just cannot treat demo accounts like real ones. If you are one of them, you might want to stick to a small real account for practice.
Notice that this material is purely educational and does not constitute financial advice. Trading involves significant risks. You should only be trading what you can afford to lose.