Circuit Breaker Technique: Avoid a Big Losing Streak
Hello, traders! Welcome to the Pro Trading Course and the second module: A Pro Trader’s Mindset.
In this lesson we are going to learn how to avoid a big losing streak by implementing something that I like to call circuit breaker technique.
Now, first of all, let me define what the circuit breaker really is. Circuit breakers are measures to curb panic selling and excessive volatility on U.S. stock exchanges. So circuit breakers temporarily halt trading on a security when price hits pre-defined tripwires. For example, in the S&P 500, the first level that triggers a circuit breaker is a drop of 7% in one day, or an intraday drop of 7% triggers the first level of circuit breaker, which halts trading for 15 minutes. Then trading restarts, and if it hits a 13% drop, it re-halts trading for another 15 minutes, and then after 15 minutes trading restarts again. If, by any chance, the S&P 500 drops 20% in one day, trading is halted throughout the day.
So basically what we’re going to do here is we’re going to grab the concept of a circuit breaker and implement it into our trading as a technique to avoid massive losing streaks or massive dropdowns.
So as a professional trader you must have in place circuit breakers to avoid having big losing days, and let me tell you something, if you don’t have circuit breakers implemented, you can actually have a very big losing day and not even notice it until it’s over. These techniques are not only about control, but also about capital preservation and avoiding panic losing streaks.
Discipline is key here. So if you’re not going to be disciplined enough to follow your circuit breakers, you should reconsider trading professionally altogether.
Now, it’s very easy, and this is why this lesson is going to be a very short one, because I want you to understand the three levels that we are going to implement. If we have 2% drop in our equity, which is the level 1, we are going on a time out for 15 minutes. You can go take a walk, have a coffee, take a shower, whatever you want, but you won’t touch your screens for 15 minutes. Then you come back and start trading again with a cool head. If you have a 3, or if you drop in equity for the day reaches 3%, then you’re in a time out for 30 minutes. I, myself, stop trading altogether after level 2, but if you’re not comfortable using two levels for circuit breakers, you can go ahead and use level 3 of 5% drop in equity. If you reach a 5% drop in equity in one day, you should stop trading altogether, and when I say you should stop trading, I mean you should stop trading for the day, and of course review all of your trades to see what happened.