Run the winners and eliminate the losers as smart traders

Letting go of winning trades and reducing trading losses is a trading rule we’ve all heard.

The idea is to let profit-making operations continue to work to earn whatever the market is willing to give.

With loss reduction, you want to get out of position and preserve your capital when you identify that your losing trade is not preparing for profit. In essence, trade is not gong to work.
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It’s an obvious trading rule and one you think would be easy to follow, but for some reason, traders do the opposite when they have an open position. Traders will cut your profits and little bank profits letting the loser keep running waiting for a bounce.
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Why don’t traders let the winning trades work?

Laurie Santos, a psychology professor at Yale, beautifully illustrates this phenomenon in her Ted Talk on Monkey Economics.

Here is a summary of the New York Times: When they were taught how to use the money, a group of Capuchin monkeys responded quite rationally to simple incentives; responded irrationally to risky bets; could not be saved; they stole when they could; he used money for food and sometimes for sex. In other words, they behaved a bit like the creature most Chen’s most traditional colleagues study: Homo sapiens.

Santos adds this to the Yale Economic Review: “when you see stocks fall to red, when you watch the price of your home go down, you won’t be able to see it in anything other than in old evolutionary terms.”

When this is combined with the high levels of uncertainty and ambiguity we experience when trading any market or any style of trading, it can be seen that it is easy to convince us that we should get some profit or that a big loser could just come back.

The markets are full of information and it is not difficult to conjure signals that support our positions (and empty those that are contradictory) when there really aren’t any.

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

  • For many, being right is about being objective and making money and we often see traders give up on a business plan and make it “fly”.
  • For some, trading rules are hard to follow

Daily trading runs this risk more often than swing trading, as traders have more trading configurations and signals to deal with. If you are an everyday trader, you need to be hyper-vigilant to make sure your trading plan is something you follow: win or lose.

It may seem that we are strongly connected to doing exactly the wrong thing that will only make it virtually impossible to find commercial success, which is already difficult.

Other merchants can hurt you

Other operators may be looking at things similar to us and acting on the same information competitively. This can make the loss much harder, especially if in doubt.

Let’s look at a simple but common example: if the market has reached a level where, if it fails to enter, a cascade of orders enters the market, a lost exit could mean a much worse price if / when you decide to close your position.

In turn, this feeds the first point and a trader can hold a trade in the hope that it will “come back”. If you come back and reward yourself with profits, you will never learn that reducing your losses is the best way to go and can lead you to business habits that will ultimately destroy you.

Trade confidence: ruined

If we look at some business statistics, you’ll see why: yours business statistics can be annihilated with only a handful of trade losses or increasing by removing a few extra ticks in each operation or by hitting the occasional home run.

Let’s say that for the reasons already mentioned:

  • In 2 trades of the set of 30, you blow
  • A loss of 6 points is lost
  • A loss of 12 points: 14 additional points of loss in total
  • The rest of the trades are taken normally

Your average trade now drops to just 0.53 points per transaction: due to only two trades! And that’s a pretty conservative scenario of what can happen when traders don’t stop.

Let’s say now that in 2 trades you get 3 extra points). So this is 2 x 3 to add to the total. The average now jumps to 1.2 points per operation, an improved figure.

Emotional balance

Confidence and emotional balance can be broken when more is lost than you know it should be and can be galvanized by taking major winners. Emotional strength is an exhausting resource that is required when things are not going particularly well, so you need to build and nurture to make sure you don’t lose control.

Over time, having the emotional strength and willpower to continue with your trading plan will help you avoid the big losses and trade shocks that these entail.

Letting go of the winners and eliminating the losers

The trading rule of the day “Run winning trades and reduce losers” is very simple. But it is far from continuing to live in practice. Understanding the absolute importance of the norm is the first step to fully adopting it.

The next step is to do it make sure your business plan is unambiguous to stop you and give you room to win winners.

So how do you let the winners run?

There are several ways to let the winners run:

  • Tracking stops
  • Reducing the risk can make winners run a little easier
  • Reduce risk as prices target a fixed profit target, such multiple or significant levels of support or resistance
  • Hold the position until a technical indicator signal, such as a moving average crossing, tells you to exit

The hardest part is have the discipline to really hold office while fighting against the desire to reap the benefits of the role. But hold on 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 as they do profitable trades.

The hardest thing about reducing a losing trade is the hope that the trade will regain its direction. We ignore small movements against your position when you first activate an entry. It is virtually impossible to choose the exact turning point, so we should expect an adverse price movement.

When it comes to adverse price movements, it comes in different flavors.

The low momentum moves against your position, keeping in mind that it is not a slow annoyance against your position, it is what you would hold most.

But when the momentum interests you, you should be on the verge of reaching the exits. Forget about waiting for the trade to return as momentum can lead, and often does, to a further momentum movement before the price picks up in the direction of the trend.

You have an exit plan

The key point in reducing losing trades and letting profits work is in fact, you have an exit plan for each position you take.

You can do something as simple as reduce the partial position to 1R and move the stop to the break-even point. When the price keeps moving in your favor, use swing points or a moving average to make even more profits.

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

Look for something and follow it