Run winners and cut losers like smart traders

Let your winning trades work and reduce trading losses – a trading rule we’ve all heard of.

The idea is to trade profitable trades to keep working to earn as much as the market is willing to give.

By cutting losses, you seek to get out of position and save your capital when you determine that your loss-making deal is not preparing to go to profit. In fact, trading does not work.

This is an obvious trading rule, and one that you think will be easy to follow, but for some reason traders do the opposite when they have an open position. Merchants will cut their profits and brings a small profit allowing the loser to continue working hoping for a rebound.

Why are traders not allowed to win trades?

Lori Santos, a professor of psychology at Yale University, beautifully illustrates this phenomenon in her talk “Ted” about monkey economics.

This is a summary from the New York Times: When taught to use money, a group of Capuchin monkeys responded quite rationally to simple stimuli; reacted irrationally to risky gambling; failed to save; stole when they could; used money for food and sometimes for sex. In other words, they behaved like a creature studied by most of Chen’s traditional colleagues: Homo sapiens.

Santos adds this in the Yale Economic Review: “if you watch your stocks fall into the red, if you watch the price of your house go down, you won’t be able to see it with anything but the old evolutionary conditions.”

When this is combined with the high level of uncertainty and ambiguity we experience when trading in any market or in any style of trading, you see that easy to convince yourself that we should get some profit either, that the big loser might just come back.

Markets are full of information and it is not difficult to evoke signals that support our positions (and close contradictory) when they really aren’t.

We all suffer from the bias of confirmation in one form or another:

  • For many, the correctness of trumps is objectivity and making money, and we often see traders abandon the trading plan and “block it”

  • For some trading rules are difficult to follow

Day trading risks more often than swing trading because traders have more trading settings and signals to fight. If you are a day trader, you need to be extremely vigilant to ensure that your trading plan – this is what you stick to – win or lose.

It may seem that we are stubbornly doing completely wrong things that will only make the search for trade success – and this is already difficult – virtually impossible.

Other traders can harm you

Other traders may well look at similar things and act on the same information competitively. This can make the loss much harder, especially if you are hesitant at all.

Looking at a simple but common example: if the market has reached a level where a cascade of orders arrives in the event of a market breakout, a missed exit could mean a much worse price if / if you choose to close your position.

This, in turn, feeds the first point, and the trader may well hold the trade in the hope that it will “come back”. If he does come back and reward you with a profit, you’ll never know that reducing losses is the best way – and can lead you to trading habits that will eventually lose you.

Confidence in trade is damaged

If we look at some trading data, you will see why – yours trading statistics can be destroyed just a few lost trades or enlarged, squeezing a few extra ticks in each trade or hitting unusual homework.

For example, for the reasons already discussed:

  • In 2 trades out of 30, you fail

  • You take one loss of 6 points

  • One loss of 12 points – an additional 14 points of loss in total

  • All other transactions are accepted as usual

Your average trade now drops to just 0.53 points per trade – because of just two deals! And that’s a pretty conservative scenario of what can happen if traders don’t stop.

Let’s say now that for 2 trades you gain an additional 3 points). So this is 2 x 3 to add to the total. Now your average value jumps to 1.2 points per trade – an improved figure.

Emotional balance

Trust and emotional balance can be destroyed if you lose more than you know, and should be strengthened by accepting important winners. Emotional strength is an exhaustive resource that is used when things are not going well – so it needs to be built up and nurtured so as not to lose control.

Over time, having the emotional strength and willpower to continue your trading plan will help avoid the big losses and trading shocks associated with them.

Let the winners work and the losers cut

The day trading rule “Spend your winning trades and cut losers” is very simple. But in practice, living is not easy. Understanding the absolute importance of a rule is the first step towards its full adoption.

Next step – make sure your trading plan is not unambiguous for stops and gives you a place to run winners.

So how do you let the winners?

There are several ways to let the winners run:

  • Stopping stops

  • Zooming to reduce risk can make the work of winners a little easier

  • Reduce risk as the price increases, to a given profit target that is multiple risks multiple times or significant levels of support or resistance

  • Keep your position until a technical indicator signal, such as a moving average crossover, tells you to exit

The hard part having the discipline to actually hold the position struggling with the desire to realize paper profits. But hold on when the drive to exit, which is not based on market realities, is the main winner.

Losers need an exit strategy as well as profitable trades.

The hardest part about reducing a lost deal is the hope that the deal will bounce in your direction. Let’s ignore the small moves relative to your position when you first start typing. It is almost impossible to choose the exact turn, so you should expect unfavorable price movements.

If we talk about the unfavorable price movement, it comes in different forms.

A low momentum moves against your position, given that this is not a slow pressure on your position – this is what most will hold on to.

But if the impulse comes against you, you have to be close to the exit. Forget about the hope that the trade will return, as the momentum can lead, and often does, to another momentum before the price recovers back in the direction of the trend.

There is an exit plan

The key to both reducing lost trades and making a profit is there is actually an exit plan for each position you occupy.

You can do something as simple as scale the partial position to 1R and move the stop to break-even. If the price continues to move in your favor, use a swing or moving average to get even more profit.

By taking the time to check which way to run winners best suits your style, the most important consistent way is to allow this trading rule to become part of your trade.

Find something – and stick to it