Avoiding Trade Management Pitfalls with thinkorswim®

August 28, 2023 Beginner
Failing to carefully manage trades can take a toll on a trader's P&L. Creating and implementing an investment strategy and sticking to it can help prevent some common trading pitfalls.

Being an engaged trader requires more than just clicking "Place Trade" and walking away—you can't "set it and forget it." After placing a trade, it's important to manage your trade. This means staying engaged with the market, and spending time making sure you're implementing an investment strategy consistently and with discipline. 
Being engaged with the market and managing trades doesn't mean you're guaranteed to profit. You must still deal with risk and loss no matter how much time you devote to trading. As you practice, though, you'll build good habits and learn more about executing your strategies more effectively.

4 ways being disengaged can potentially hurt your trades

If you're only nominally engaged and not carefully managing trades, you might find your account isn't generating the returns you'd like. So how do you attempt to improve your results? Let's review four possible scenarios that might relate to your lower returns and consider how they can potentially be rectified with the right strategy and active engagement.

1. A winning trade turns into a loser

Analysis. There's no foolproof strategy to make sure a winning trade never loses. You might be moving forward with a successful trade, only to have the market move against you. But you can't do anything to minimize a loss if you don't even know it's occurring.

Action. Log in to your thinkorswim® platform account and check your positions every day. Look at the daily profit and loss ("P&L") of your positions by selecting the Monitor tab in the Position Statement section. Above all, know which positions are winning and losing. If you have a trade on with a profit, consider using a stop market1 or stop limit order2 with a trigger price that may potentially help protect some of that profit if the trade falters. A stop order is no guarantee of profit, but it could potentially prevent a winner from becoming a loser.

2. Letting a small loss turn into a large loss

Analysis. A losing trade in your Position Statement will surely get your attention, but it could also cause you to freeze. You might feel helpless and unsure of how to proceed. But taking action can help you manage losses and potentially keep them from ballooning.

Action. Start by acknowledging the loss and then consider a strategy that can potentially reduce the loss. For example, if you're an option trader, is there a call you can sell against long stock to reduce the stock's break-even point3 while limiting the upside potential of the stock? Premium received from the covered call can offset some of the losses, but the trader is now obligated to sell the stock at the strike price anytime up to expiration.

In some cases, there might be an unexpected reason the trade is losing money. Other market conditions might be causing a setback, and sometimes it might make sense to exit the trade with current losses, before they get larger.

3. Waiting for a great opportunity

Analysis. Relying on consistent criteria can help you separate bad trades from potential opportunities. But if your criteria are too narrow, you may get stuck waiting for an opportunity that never comes. Having a wide variety of potential strategies and criteria can help you find more trade opportunities. Those criteria could be something like reward versus risk. Or positive theta4 and defined risk. Or strong financials and diversification. You might also consider charting patterns and technical analysis.

Actions. Research and compile a list of new strategies or trade criteria, and then use paperMoney® on thinkorswim, as shown in the image below, to experiment with trading without using real money. This practice run could help you refine your approach and understand which strategies could work for your trading style.

Practicing with paperMoney

Image shows an example of the paperMoney platform that resembles the thinkorswim platform, illustrating that paperMoney is a good place for traders to test out different trading strategies in a practice environment.

Source: paperMoney platform

4. Suffering from analysis paralysis

Analysis. Markets are complex, and of course trading involves risk. You can always ask one more question about a stock, company, or strategy. Even if your indicators line up, fear of losses may make you reluctant to move forward. A lack of confidence can hamstring your trading before you even begin.

Action. One way to trade with confidence is to know upfront how much you're risking. If you don't know what the max loss is, load the position as a simulated trade on the Analyze tab to find it. Next, divide that max loss by the Net Liquidating Value of your account. (To see your Net Liquidating Value, refer to the Account Info pane on the upper left corner of the platform and look at your account's Net Liq & Day Trades). What's the percentage? This puts the potential loss in perspective. If your net liq is $5,000, and the max loss on a short vertical,5 for example, is $70, the loss would represent 1.4% of your account value, not including commissions. You don't want to lose 1.4%, but is that a risk you can accept for a given strategy? Being able to answer that question can you help you move forward with confidence.

Becoming an engaged trader

Carefully managing trades and practicing strategies can help you better understand how underlying market conditions impact a trade over its lifecycle. It doesn't guarantee profit, but over time, you'll hopefully gain a certain amount of expertise, wisdom, and instinct.

It's not always just about buying and selling but how you approach the investment process.

1 Upon activation, a stop market order becomes a market order. The benefit of a stop market order is that it will seek immediate execution once the activation price has been reached. The disadvantage of a stop market order is that the client does not have any control over the price at which the order executes. There is no guarantee the execution price will be equal to or near the activation price.

2 An order to buy or sell a stock that combines the features of a stop order and limit order. Once the activation price is reached, a stop limit order becomes a limit order that seeks execution at the specified limit price or better. The benefit of a stop limit order is that the investor can control the price at which the order can be executed. However, a stop limit order also carries the risk of missing the market altogether because it may never reach, or it may surpass the specified limit price. In a fast-moving market, it might be impossible to execute an order at the limit price, so you may not have the protection you sought.

3 The breakeven point in options trading occurs when the market price of an underlying asset reaches the level at which a buyer will not incur a loss.

4 A position that benefits from the time decay (theta) an option experiences as time passes.

5 A defined-risk directional spread strategy composed of an equal number of short (sold) and long (bought) calls or puts with the same expiration in which the credit from the short strike is greater than the debit of the long strike, resulting in a net credit taken into the trader’s account at the onset. Short call verticals are bearish, while short put verticals are bullish. The risk in this strategy is typically limited to the difference between the strikes minus the received credit. The trade is profitable when it can be closed at a debit for less than the credit received. Breakeven is calculated in a short put vertical by subtracting the credit received from the higher (short) put strike, or in the case of a short call vertical, adding the credit received to the lower (short) call strike.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the Options Disclosure Document titled "Characteristics and Risks of Standardized Options" before considering any options transaction. Call Schwab at 800-435-4000 for a current copy. Supporting documentation for any claims or statistical information is available upon request.

With long options, investors may lose 100% of funds invested. Spread trading must be done in a margin account. Multiple leg options strategies will involve multiple transaction costs. Commissions, taxes and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

paperMoney® on the thinkorswim® platform: This software application is for educational purposes only. Successful virtual trading during a one-time period does not guarantee successful investing of actual funds during a later time period—market conditions change constantly.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.