Why do traders find it difficult to cut losing trades early?
I feel every trader has been in this situation before where a trade is going against you but you think you're right, so even though the market has changed, we continue to hold the trade until our stop loss is taken.
If that sounds familiar to you, then please be assured you are not alone.
The golden rule of 'cut your losses early and let your winners run' sounds simple, but in practice is probably one of the hardest tasks to perform. It took me a while to get over this, when a trade went against me in the past my mindset would be one of hope. Hoping the position would come good so I didn't have to realise the loss in my account. These days I cut losing trades super early if the conditions change, without giving it much thought.
In this post I want to go through some rules I use to cut losses early, and try to extend my winners.
Don't get me wrong winning a trade can feel pretty good, it shows that maybe your analysis was right and it can confirm the idea you had so you can repeat the process in the future. On the other hand losing can really hurt.
Believe it or not, studies have shown that the pain of losing is about twice as powerful as the pleasure of gaining. So when the trade is going against us, our brains try to step in and tell us to hold rather than cut. A big point to this is realising the loss. When a trade is in play and the p&l is moving up and down, the position is known as a paper loss or paper gain. It isn't real until it is over with. So if we don't close the losing trade, it only harms the equity and not the balance. Psychologically this plays a huge role in cutting losses early.
One of my big problems was wanting to win and be right. In short, I had an ego. It would hurt me to spend so much time analysing market trends, macro indicators and sentiment tools to then lose a trade. It sucked. I felt that I was wrong and that the loss meant I didn't know what I was doing.
I'd say I took it personally.
Instead of accepting a loss and using it to learn, I would convince myself I was right and would either let the market take my stop losses or even move my stop loss to increase the loss. This would lead to all sorts of problems.
One of the most freeing thoughts a trader can make is realising your job isn't to be right, your job is to be profitable over some time.
If you're like me and you consume a lot of trading podcasts and videos or watch interviews with traders, you will realise a few common traits between them. They all have losing trades.
A couple of people I watch consistently are well known hedge fund traders and have both been featured in the market wizard books, Jason Shapiro and Linda Rashke. They consistently say that they lose trades, or they have stop losses in place to limit losses if they are wrong. These guys manage millions of dollars. If they can lose trades then you better believe you can lose trades too.
So try to use the knowledge of big traders or successful traders also losing as a sign that it's ok to lose too. It can be very liberating for your mind.
I always say that I was fortunate to meet and have some friendships with some successful traders. One particular moment when I was trading with one of them really stuck with me and still does to this day.
His name was Charles, and he would monitor my trading positions to give me feedback on how I could improve. One day I was in a trade and it was actually in profit, but the conditions of the trade started to change. The upward trend I was trading began to reverse, he messaged me almost immediately and said "What's going on with AAA/BBB". At the time I was like, I don't know it's in profit so I will hold it. He went berserk at me. Honestly, it gave me the frights a little. He was very adamant that I should close the position because the conditions were no longer there, but it was ultimately my decision. So, in a bit of defiance, I left the trade open. It lost.
From that moment on I vowed that if the condition changes, I will exit my position. This really helped me, because I often placed my stop losses below significant levels, and the change of condition would come before that in most cases. So I found I was beginning to cut my positions early because conditions were changing. We have to remember the longer a trade goes on the more information we get. If conditions change, why shouldn't our opinion change?
By the way, this helped my winners ride too. Why? Because I just asked myself the question, has anything changed? Is the condition the same? If it was I'd just stick with the trade until it hit my hard take profit or my trailing stop loss.
Hopefully, this information can help you with your trading, let me know if it does.