Updated from its original posting on 08-07-2011
In the middle of a winning forex trade, have you ever asked yourself, “Should I take profit now or should I let it run?” Maybe there were times when taking profit early proved to be the better decision. But I’m sure there were also instances when you smacked yourself at the back of the head for closing your trade too early.
Why do traders tend to cut profits early anyway? Here are three possible reasons:
One could be because they have no clear profit targets in mind. There’s nothing wrong about determining your profit target as your trade plays out. It’s just much easier to stay on a trade with a CLEAR profit target as it is easier to finish a task with a goal in mind.
A trader’s lack of appetite for risk may also contribute to premature profit-taking. Some traders would rather have that sense of certainty and bank in at a profit of 10,000 USD rather than risk a portion of their unrealized profits for another 5,000 USD.
Lastly, there’s also the confidence issue. Holding on to your trade until price reaches your profit target requires not only a great deal of patience but also a considerable amount of confidence. There will be plenty of uncertainties along the way, which means that staying confident with your trade idea becomes even more challenging.
It doesn’t help that, as you watch your potential profits grow, it gets even more tempting to lock in those wins rather than risk the possibility of losing them by keeping your trade open. A bird in the hand is worth more than two in the bush, so they say.
But more than the potential loss of unrealized profits, it’s the frustration that often accompanies these missed opportunities that hold a trader back. As traders, we tend to be a tad too hard on ourselves especially when paper profits vanish into thin air. Maybe we cut our profits short to avoid blaming ourselves in the event that we lose unrealized profits.
This is probably why my favorite trading psychologist Dr. Brett Steenbarger noted that much more confidence is required to hold on to a winning trade as it goes in your favor. But how exactly can you achieve this level of confidence?
Yep, it’s that simple. Too bad it’s not as easy as it sounds. You must be able to trust your trade idea so much that you follow through until your planned profit target. I know it’s not exactly a walk in the park, but the only way to maintain confidence amidst uncertainty is to believe in your time-tested strategies and your trading experience.
Dr. Steenbarger says that building trust can be accomplished in two ways. First is by instilling a confident mindset, wherein you mentally prepare yourself in advance just in case price retraces and your paper profits are erased. So when you’re in a trade, determine the possible retracement areas and set your trailing stops accordingly.
There could be times when what initially seemed like retracements turned out to be reversals and you get stopped out. Don’t beat yourself up over the lost profits. Instead, remind yourself that at least there was no damage to your account and that there are plenty of other opportunities.
Another way is to build on small change. By this, Dr. Steenbarger means that you should do a little of the right thing at a time and build on those efforts in order to start making bigger changes.
For instance, you can try locking in some of your profits at some point and leaving the rest open, either to hit your profit target or your stop loss. This way, you are able to realize profits and at the same time exercise confidence in seeing your trade until the very end.
It’s not every day that the market goes your way. But when it does, wouldn’t you want to make the most out of it?