Understanding the Cut and Reverse Trading Strategy

Cut and reverse trading strategy aims to offset a losing trade by opening new trades in the opposite direction from the initial trade.

What will you do when your trading plan goes awry? For example, you have bought the EUR/USD, but then the Federal Reserve announces a controversial move that drives the USD higher. In such a situation, the first step is to cut the loss as soon as possible. Next, you can apply the cut and reverse trading strategy.

What is the Cut and Reverse Trading Strategy?

Cut and reverse trading strategy aims to offset a losing trade by opening new trades in the opposite direction from the initial trade, with the expectation that profits from the second trade will be greater than the loss from the first trade. Basically, reverse your position whenever your initial trade suffers a loss.

Cut and reverse trading strategy generally can be done in this order: first trade loses -> cut loss -> open new trade in the opposite direction. Also, as it is supposed to offset the losing trade, the second trade should be of the same size or larger.

This strategy seeks to provide a solution for traders to revise their trade results as soon as possible and respond to a sudden change in market trends without losing the opportunity to make a profit.

A cut and reverse strategy should be used only if prices break through key support or resistance, according to technical analysis. Reversing a long position should only be done if prices have broken a support level, while reversing a short position should only be done if prices have broken a resistance level.

Determine Trade Sizes for the Cut and Reverse Strategy

In order to efficiently offset your losses, it is important to consider position sizing carefully. The question is, should the second trade be the same size or larger than the first trade?

A conservative trader will probably open all trades at the same size. As it is easier to manage risk and organize money management under such rules, beginner traders will also benefit from similar decisions. However, risk-takers may use the Martingale system.

The Martingale system requires a trader to halve double-losing bets. If you lose 1 lot in the first trade, then open 2 lots in the second trade, 4 lots in the third trade, and so on. It is essentially a technique that encourages a loss-averse mindset in an effort to boost the chances of breaking even. Yet, it also raises the risk of big losses that happen quickly.

Other Ways to Deal With Losing Trades

Cut and reverse is not the only strategy you can take in dealing with losing trades. There are also various other options, such as the original Martingale trading strategy, Anti-Martingale, Averaging, and Hedging.

The original Martingale does not require traders to close the first losing trade. Instead, traders will open new trades in larger sizes in the same direction as the first losing trade, all the while preserving the first trade. This involves more risk than Cut and Reverse but also promises bountiful profits if it works well.

The Anti-Martingale is the opposite of the Martingale as it seeks to reduce the effect of losing streaks by halving subsequent trade sizes after the first losing trade. If you lose 4 lots by buying EUR/USD in the first trade, then buy 2 lots of EUR/USD in the second trade, and so on.

Averaging aims to average prices in our portfolio. As such, traders will open all trades at the same size. A trader using the "averaging down" approach will open new trades in the same asset once the price has plummeted. The average price at which the trader bought the asset decreased as a result of this second transaction.

Lastly, Hedging seeks to open new trades in the opposite direction once the first trade loses while preserving the first losing trade. This is not an easy path to take, because traders have to make sure that prices move in a range (instead of a strong bullish/bearish trend) in order to gain sufficient profit from both trades.

So, which strategy is best? As our elders say, all roads lead to Rome. Cut and reverse, Martingale, Anti-Martingale, Averaging, and Hedging, all can be applied in different circumstances. 

None of them is better than the others. The success of your trades depends on the mastery of your chosen strategy, instead of which strategy you have implemented on your account.