Trade management is a very important aspect of trading. In our opinion, most traders respond emotionally to price action on their charts rather than effectively managing their trades. In this article, we discuss the advantages and disadvantages of active and passive trade management and provide some tips on how to evaluate your own trading effectively.
Introduction: What is Active and Passive Trade Management?
Active trade management describes an approach where the trader actively, hence the name, moves around stop loss and take profit orders, or scales in and out of trades. This is usually done because the trader believes that he or she can react to changes in price movements and potentially optimize performance.
Passive trade management, also often called ‘set and forget,’ is an approach where the trader does not interfere with their trades once a position has been entered. They then wait until either the stop loss and take profit order has been hit. The goal of this approach is to eliminate the emotional problems that come with active management.
The Problem of Micro-Management
Micro-management is a big issue for many traders who follow the active trade management approach. This is especially true for new traders who believe that they constantly have ‘to do something’ with their positions to improve their chances of realizing a successful trade. However, micromanagement is often driven by emotions and traders just ‘trade their PnL,’ which means that they don’t respond to the actual price movements on their charts, but focus more on the money they can win or lose on their trades.
Micro-management is also a result of trading without a plan. Most traders spend a lot of time trying to perfect their way of timing entries and then completely neglect the importance of trade management. Then, once they are in a trade, they are clueless and don’t fully understand how to react.
The last moment of objectivity is before you enter your position. Once you are in the market, many traders have difficulties staying objective. Having a pre-written trading plan and being clear on how to approach your trade will often remove a lot of the uncertainty and the problems that come with micro-management.
The Pros and Cons of Active Management
Micro-management is the biggest problem with the active trade management approach. In that context, moving stop loss orders too soon to the point of entry (break even) and then being taken out by a small retracement is a common phenomenon. Price moves in waves and you will see that across asset classes and time frames. Thus, a trade needs ‘space to evolve’ and moving stops too aggressively can cause significant problems for many traders.
When traders are glued to their screens and follow their trades tick by tick, they tend to give too much weight to short-term retracements. Every small tick against their trade suddenly looks like a potential reversal. Again, having a pre-written trading plan can be of great help here.
On the other hand, active trade management can potentially have advantages when a trader catches a strong move early on and then has the chance to maximize his profits by adjusting his take profit levels. However, most struggling traders would usually do better when trying to reduce the downside risk and not trying to squeeze out a few more points.
Stoploss Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.
The Pros and Cons of Passive Management
The passive trade management approach can help a trader build confidence and gain the understanding of price movements and his system, especially if they are just starting out. It can also reduce the emotional problems that come with micro-management.
The hardest part here is that the trader must be reasonable with his stop loss and take profit levels to begin with. However, just being an observer of price and your trades can often be a real eye-opener for traders. They can pick up on aspects of their method and price which are often overlooked when actively managing trades.
The disadvantage is that a trader cannot maximize profits as efficiently since it is capped by using fixed targets. However, most traders will see when they look at their past performance that the benefits of eliminating emotional issues can potentially outweigh the disadvantages of smaller winning trades.
How to Approach and Grow as a Trader
We suggest most traders start by following the passive trade management strategy, gain insights on their method over time and work on refining other trading skills and chart reading abilities. We realize it will be hard to resist not interfering with your trades, but you will quickly see the benefits that come with it. We also recommend taking screenshots of your trades. This simple but effective technique will reveal how price reacts to your trades and you will be able to judge your trade management decisions going forward. This will not only build confidence but can be a real eye opener for some traders.
There is a substantial risk of loss in FOREX trading. Past performance is not indicative of future results.
Written by Raymond Heriel Chief Currency Analyst at profxtigers