Execute the winners and weed out the losers as smart traders

Allowing your winning trades to run and cutting your trading losses is a trading rule we’ve all heard.

The idea is to let profitable trades continue to get as much as the market is willing to give.

By cutting your losses, you are looking to exit the position and preserve your capital when you identify that your losing trade is not being set up to make a profit. In essence, trade will not work.

It’s an obvious trading rule and one you’d think would be easy to follow, but for some reason, traders do the opposite when they have an open position. merchants cut your profits and deposit small winnings while let the loser keep running waiting for a bounce.

Why do traders not allow winning trades to be executed?
Laurie Santos, a professor of psychology at Yale, beautifully illustrates this phenomenon in her Ted Talk on the economy of monkeys.

This is a summary from the New York Times: When taught to use money, a group of capuchin monkeys responded quite rationally to simple incentives; responded irrationally to long shots; save failed; they stole when they could; they used money for food and sometimes sex. In other words, they behaved a bit like the creature most of Chen’s more traditional colleagues study: Homo sapiens.

Santos adds this in the Yale Economic Review: “When you see your stock crash into the red, when you see your house price go down, you won’t be able to see it in anything other than old evolutionary terms.”

When this is combined with the high levels of uncertainty and ambiguity that we experience when trading any market or any trading style, you can see that it’s easy to convince us that we should bank some profit or that a big loser might come back.

The markets are full of information and it is not difficult to conjure signs that support our positions (and delete the ones that are contradictory) when in fact there are none.

We all suffer from confirmation bias in one way or another:

  • For many, being right trumps being objective and making money and we often see traders give up a trading plan and “fly”.
  • For some, trading rules are difficult to follow

Day trading takes this risk more often than swing trading because traders have more trade setups and signals to deal with. If you are a day trader, you need to be very vigilant to make sure your trading plan is something you stick to – win or lose.

It can seem like we are programmed to do exactly the wrong thing that will only make finding trading success, which is already difficult, virtually impossible.

Other merchants can hurt you
Other merchants may be looking at things similar to ours and acting on the same information competitively. This can make taking a loss much more difficult, especially if you hesitate.

Looking at a simple but common example: If the market has reached a level where, if you break above it, a cascade of orders flow into the market, a missed exit could mean a much worse price if you decide to close your position.

This, in turn, feeds into the first spike and a trader may well hang on to a trade in the hope that it will “come back”. If he comes back and rewards you with profits, he will never learn that cutting his losses is the best way to go, and may lead him into trading habits that will eventually destroy him.

Trust to Trade: Ruined
If we look at some trading statistics, you’ll see why: your trade stats can be wiped out with just a handful of losing trades or boosted by squeezing a few extra ticks out of each trade or hitting an odd home run.

Let’s say that for the reasons already mentioned:

  • In 2 exchanges in the set of 30, it explodes
  • You take a 6 point loss
  • A 12-point loss – an additional 14 point loss in total
  • All other exchanges are taken as normal.

Your average trade is now down to just 0.53 points per trade –
for only two trades! And this is a pretty conservative scenario of what can happen when traders don’t take their stops.

Let’s say now that in 2 operations you get 3 additional points). That’s 2 x 3 to add to the total. His average now jumps to 1.2 points per trade, an improved figure.

emotional balance
Confidence and emotional balance can be shattered when you lose more than you know you should and are galvanized by taking significant profits. Emotional strength is an exhausting resource that is called upon when things aren’t going particularly well, so it must be developed and nurtured to ensure that you don’t lose control.

Over time, having the emotional strength and willpower to stick with your trading plan will help you avoid big losses and the accompanying trading shocks.

Let the winners run and the losers cut
The day trading rule “Execute your winning trades and eliminate your losing ones” is very simple. But it is far from easy to live in practice. Understanding the absolute importance of the rule is the first step to fully accepting it.

The next step is make sure your trading plan is unambiguous about taking stops and gives you room to execute winners.

So how do you let the winners run?

There are several methods to let the winners run:

  • final stops
  • Scaling out to reduce risk can make letting winners run a little easier
  • Reduce risk as price heads to a set profit target, such as multiple risk or significant support or resistance levels
  • Hold the position until a technical indicator signal, such as a moving average crossover, tells you to exit

the hard part is
have the discipline to fill the position while fighting the urge to realize the earnings on paper. But hanging in there when the urge to get out that isn’t based on market reality is where the big winners come from.

Losers need an exit strategy just like profitable trades.

The hard part about cutting a losing trade is hoping that the trade will bounce back in your direction. Let’s ignore the small moves against your position when you first trigger an entry. It is practically impossible to pick the exact turning point, so we should expect some adverse price movement.

When talking about opposite price movement, it comes in different flavors.

Low momentum moves against your stance, considering it’s not a slow grind against your stance, are something most would stick with.

But when momentum works against you, you should be close to reaching the exit. Forget waiting for the trade to come back, as momentum can and often does lead to one more momentum move before price resumes in the direction of the trend.

have an exit plan
The key point in both cutting losing trades and letting profits run is actually have an exit plan for every position you take.

You can do something as simple as scale the partial position on 1R and move the stop to breakeven. When the price continues to move in your favor, use reversal points or a moving average to look for even more profit.

While you take the time to test which method of executing winners best suits your style, the most important thing is a consistent method of allowing this trading rule to be a part of your trading.

Find something and stick with it

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