Revenge trading refers to the situation where you open one or more trades in a bid to recoup one of your big losses. It is a common mistake among many beginners and experienced day traders. In this article, we will look at what revenge trading is, the risks involved, and how you can avoid it.
What is revenge trading?
Revenge trading in forex, stocks, commodities, and exchange-traded funds (ETFs) is a situation when you attempt to recover your funds after you make a big loss. For example, if you have a $10,000 account and open a trade that loses $1,000, you might have the urgency to recover these funds. These trades are often opened in a hurry with a simple goal of making back the $1,000 that you lost.
Revenge trading is never recommended because of the risks involved. In my more than a decade of experience in the industry, I have seen many people who have blown their accounts simply by attempting to recover their funds.
However, at times, it is possible to bounce back. This is what happened to me early in my career. At one point, I had a goal of making $2,000 per week in profits. Then, on a Friday, I realized that I was $50 short of my goal. And so, I decided to open a trade to get to my target. Sadly, that trade went south, and within a few minutes, I had lost more than $300. And so, I ended the trade and went back in.
Fortunately, my revenge trade went well, and I managed to recoup my initial losses and move past my weekly target. However, in my experience, most people who revenge trade tend to lose their money.
Revenge trading is driven by several factors. First, it is driven by greed, where the trader is not willing to take a loss. Second, it is also driven by fear of seeing your hard-earned money disappear. Third, there is the risk of being fired, especially when you are working in a proprietary firm, hedge fund, or investment bank. Fourth, it is also driven by shame, where you are not comfortable losing money.
The risk of revenge trading
Revenge trading is often risky, and many times, it leads to substantial losses rather than profits. There are several reasons for this. First, most trades initiated using this process are usually not well-researched. As such, there is usually a possibility that the trader will make more losses than what they did initially.
Second, at times, the trades are usually bigger than the original one since the trader simply wants to recoup their losses. Therefore, if the trader had a lot size of 0.5 in the original trade, they will open a trade with a bigger lot size in a bid to recover the funds faster.
Third, there is the risk that the emotional torture of the initial loss will have a major say on the trader. In most cases, traders who do well are those who are in a good emotional state.
How to avoid revenge trading
Fortunately, there are several strategies that can help you avoid revenge trading. Some of these are listed below.
Having a stop-loss for all your trades
At times, revenge trading happens when a trader makes a big loss. Therefore, one way to avoid the situation is to ensure that you have a stop-loss for all your trades. For starters, a stop-loss is a tool that automatically stops your trade when it makes a certain pre-set amount of loss. For example, if you open a bullish trade on the EURUSD at 1.1200, you could set a stop-loss at 1.1100. In this case, the maximum loss you can make for this trade is 100 pips. As such, you will always be sure that you can’t make a bigger loss than that no matter what happens.
While a stop-loss is a good tool, a trailing stop-loss is even better. Like the stop-loss, it will stop a trade automatically, but it will move with the trade. The trailing stop is better because it helps to limit a situation where a currency pair rises and then crashes. It helps to capture the initial profits before the drop.
Have a trading journal
A trading journal is a document where you write all details of your trades. Most traders these days use digital trading journals instead of the traditional ones that are paper-based. A journal has several sections such as the currency pair, entry point, reason for exiting and entering the trade, and the motivation behind it.
A journal will not directly help you avoid revenge trading. But it will help you build more discipline when trading. In my experience, I have found out that most successful traders are those who incorporate journals in their trading.
Making a big loss can be disappointing simply because everyone hates losing. Therefore, at times, you can decide to take some time off in a bid to avoid the mistake of revenge trading. For example, if you made a big loss in a morning session of your trading, you can decide to take the afternoon off. While you will not make any money when taking time off, doing so will help you to reset your situation. It will also help you avoid making the mistake of opening low-quality trades.
Set and follow entry rules
Finally, you should set entry rules for all trades. This simply means that you should only enter trades when certain conditions are met. For example, if you trade using a Moving Average, you should only enter trades when the Moving Average gives you the right signal. With such rules, you will be in a good position to avoid revenge trading.
Revenge trading is a common thing that happens among many day traders. Yet, it can often lead to substantial losses when left untreated. In this article, we have looked at the reasons why people revenge trade and some of the main strategies to avoid it.