Updated from its original posting on 2013-03-15
In my previous articles, I’ve emphasized the need to review your losing trades to see what lessons can be learned. In this edition of Pipsychology, let’s take a look at winning trades and what can be done to maximize your wins.
Sometimes not enough attention is given to profit targets, which is a pity because being able to maximize profits can greatly affect one’s bottom line. Traders that have difficulty letting winners run may miss out on big moves in fear of losing potential profits.
In the long run, such traders tend to have a hard time staying profitable because their winning trades aren’t much larger than their losing trades. Sometimes, their average winning trade will even be smaller than their average losing trade.
Why do traders do this?
There are a number of reasons why traders have difficulty maximizing their winners. Three of the most common are:
1. You have no profit target in mind.
It’s hard to get anywhere if you don’t know where you’re going. This couldn’t be more true for trading. If you don’t have a goal or profit target in mind, you can easily get distracted or carried away by market noise, which can cause you to close your trade prematurely. Learn to use firm profit targets and you’ll see how much easier it can be to hold on to your winning trades.
2. You don’t feel very confident about the trade idea.
Newbie traders are often guilty of entering trades based on another person’s analysis and/or system. Heck, there are times when they even copy trades outright, without considering the rationale behind the trade idea!
In such cases, a trader may be struck with a lack of confidence, which in turn may lead him to exit the trade at an inappropriate time.
3. You are too risk averse.
While knowing how to manage risk is a critical trading skill, there is such a thing as being too risk averse. Remember, you cannot completely avoid risk, but you can manage it. The trick is to know when a risk is worth taking.
For example, let’s say that for the same $500 risk, you were given a choice between bagging a sure $1,000 profit and getting a 75% shot at bagging $2,000. Which would you take?
Many would choose the sure $1,000 profit, even though taking the 75% chance of making $2,000 has a higher expected value and makes more money in the long run.
The truth is, it’s all in the head.
Yes, traders are afraid of losing potential profits, but what is a more serious problem is the potential consequences it can have on a trader’s psyche.
What happens when a trader “misses out on profit” when he doesn’t close out a trade is that he tends to blame himself for not booking the profits. This is the wrong mentality to have, as it means that he is not comfortable with losing and doesn’t understand that it is part of the business.
Moreover, traders tend to think that when they close a position at market in order to book profits, it’s all just part of the trade management process. In reality though, they aren’t managing the trade but only acting to help ease the emotions surrounding the trade.
In order to build the confidence needed to ride out a winning trade, one must build trust in his own abilities.
Let me give you a clearer example. For those of you who drive, I am sure you are confident in your skills and that you trust yourself enough to be in control despite random road conditions. You don’t panic or just stop driving because things get hectic – you just keep on driving to your destination.
Well, that’s how trading should be, my friends!
The question is, how do you build confidence in your trading?
Before you even start trading, you need to visualize what you are going to do once it comes to a point where you have to make a decision to either close the trade or let it run. Imagine talking to yourself, saying “No pain, no gain.” You have to learn how to be comfortable with the tension that comes with holding on to a trade. Realize that in the long run, it will pay off.
You have to accept that this won’t change overnight, but what you can do is to make small changes in your trading, moving towards your goal. Remember, small changes add up to big changes. One exercise you can start practicing is splitting up your position into two smaller ones. This way, if you feel the urge to close out your trade, you can close one of the positions while letting the other one ride. Over time, you can start changing the ratio of the weights of the two positions when you are more confident in letting your trades run out.
Lastly, I want to leave you with this little tidbit: don’t be afraid to be wrong and be confident in your own abilities! This will serve you well in your career as a developing forex trader!