One of the hardest decisions you will have to make while trading Forex is when to quit a losing trade. Do not think you are going to get out of this by having a perfect system; while the best thing to do is obviously to avoid losing trades in the first place, even with a really, really great system, it is going to happen. Not only that, but a lot of Forex traders struggle to figure out if they are in a losing trade at all, particularly traders whose systems often take them out of their way on retracements before getting back on track.
When price is going against you in a backtest, it is easier to make trading decisions than it is in real life. You have less time to think about the situation since you are not waiting on the bars to form, and you often get into a pattern of actions which at the time seems very clear and simple. In real time, though, as the minutes, hours or days drag by, you have a lot of time to second guess yourself. What would have seemed clear in a backtest suddenly seems like a muddle. You will think things like, “Am I really losing this trade? It is going to turn around if I just wait. Or maybe it will not. Maybe I will just lose more and more money until I hit my stop. Maybe my stops are too close; if I just push out my stop a bit then price will turn around. This is probably a retracement, but I do not want to sit around to find out, so I am going to get out early.” And so on.
Some of these thoughts err on the side of caution while others err on the side of excess. In both cases, however, you can lose money unnecessarily, whether by trying to ride out a losing trade in hopes it will “turn around on you” or by getting out early at a small loss, only to see price retrace and then go on to a big win.
If you are used to having price retrace on you and then go on to win, you may want to consider just looking for the retracements as part of your setup in the first place, and entering after retracements complete. This can save you from getting faked out in either direction. Generally speaking, though, there is a really good, simple rule for figuring whether you are in a genuine losing trade or whether your trade might still make sense. That is to ask yourself this question: “Do the reasons for making the trade no longer exist?”
If the reasons you originally took the trade no longer exist, you should probably get out and cut your losses. If you would not enter the trade with things as they are, then it is not an intelligent position to be in. Do not sit there waiting for price to turn around on you — there is no reason to think it will. At that point you are gambling and you are in the wrong mindset anyway, so get out of the trade.
If however the reasons you took the trade seem to be intact, you may just be in a retracement, especially if new signals have formed in the direction of your trade since you entered it. In this case, it may be a good idea to stay in. Try to make the decision you would have made when backtesting. If you were not double guessing yourself, what decision would you make? Hopefully these tips will help you to cut your losses in Forex without cutting yourself out of winning trades!