The common bad trading habit of holding onto loosing trades for long and cutting winning ones too early
A common condition that impacts most novice traders, is the destructive habit of holding onto losers too long and cutting our winners too early. The reasons for this intervention in our trades are many and complex. However, the overriding motivation for this behavior is: a lack of emotional control, failing to adhere to our well-crafted trading plan and not adopting automation as a method of trading; whether that’s semi automation, or full automation.
Without a doubt the issues we’ve highlighted regarding self-control affect novice traders primarily. Due to a lack of experience and a propensity to ‘live in the now’, as novices we often become over-excited and emotionally involved in the trades we have placed into the markets. We witness profits accumulating in our account balance and the trade direction moving in our way and we become over excited. Alternatively, we observe losses and we become overly disappointed.
In fact many trading studies have revealed that we experience the emotional pain of our losses far more than the emotional enjoyment of our wins. These various peer reviewed studies highlight a significant issue; if we let this phenomena affect our trading, then the detrimental effect on our profitability can be devastating, our losses will accumulate and our winning trades will diminish and we’ll rapidly incur irretrievable damage to our trading funds. We’ll become excited at the first evidence of a winner and desperately hold onto losers, expecting to either limit the damage, or for the losing position to eventually turn around.
Is our risk is too high?
It’s often stated that the individual trades we place into the markets should be visualized as writing a personal banking cheque; you’re paying for an opportunity that’ll either return you a profit, or subject you to a loss. But you must be in an emotionally neutral position when writing that cheque. The cost of writing that cheque and taking that risk should matter, but not impact your emotional stability too much. You should recognize the random nature of the market, its unpredictability and the random distribution of winners and losers and therefore moderate your risk accordingly.
If you’re becoming emotionally involved in your trading then the cure is straightforward; we dial down our risk until we reach a level whereby the palms of our hands stop becoming sweaty and our heart beat doesn’t rise when we have trades in the market. If we’re beginning to develop nervous traits risking 2% risk per trade then we should consider only 1%. If we’re still sweating on the outcome then consider 0.5%. Still too much? Then consider 0.25%, you must find a level at which you’re relaxed about the outcome. Being relaxed over the outcome doesn’t mean you’re reckless, or that you’ve abandoned any form of responsibility or professionalism, it indicates that you’re now risking the right level of your funds, appropriate to your emotional control and (indirectly) your level of experience.
Do not breach the rules in your trading plan, you may add semi automation.
The temptation to adjust our trades can be dealt with once and for all, completely and surgically by only trading within the parameters of your trading plan. Whilst manual trading is acceptable, freehand trading isn’t. You should never trade without a stop, and rather than make that stop a mental stop, make it a hard stop and always have an emergency stop in place too. Once you’ve made that commitment then you’ve made the first step to avoid breaching the trading plan.
You’re risking perhaps 1% on the trade, that’s it. Never widen the stop, never alter your risk. You don’t cut short the trade if it’s in a winning position, you don’t widen the stop if you’re in a losing position, hoping the trade will turn around and move into profit. We also have the opportunity of moving into semi-automation by setting a take profit limit order combined with a stop, we can then also place our trade entry orders into the market near critical levels we’ve identified that would represent a development in terms of price action.
« How to correctly draw trend lines on a chart when Trading Forex MORNING ROLL CALL »
