A Counterintuitive Approach to Letting Your Profits Run
And how to exit a trade without regrets.
Have you ever closed a trade too soon, only to watch the market continue in your favor after you've exited? Like many traders, you may also be struggling with this regret.
Let me show you how to break this cycle. Understanding why and how to prevent this can significantly improve your trading results.
Otherwise, you will keep suffering from regret even after making a profitable trade - just like the scores of traders who never learn how to let their winners run.
Deep down, the fear of losing a trade is holding you back.
Here are some more reasons for this behavior:
Lack of deep knowledge of effective trade management.
Emotional trading decisions driven by fear and stress.
Misunderstanding the importance of exit strategies.
Overreliance on high winning rate systems.
Inadequate focus on risk management and projection of losses.
The good news is that you can improve your trading performance by understanding and managing your trades better.
Now, let's dive into how you can overcome these challenges and start letting your winners run.
#1. Understand Prospect Theory
It was created by Daniel Kahneman and Amos Tversky in 1979, and the idea helped them win the 2002 Nobel Prize in Economics.
Prospect theory is a way to understand how people make choices with money. The theory says that people think about winning and losing money differently. They care more about not losing money than about winning money. This means traders might exit a trade too early to lock in a small profit, even when there's potential for a much more significant gain. Recognizing this behavior is the first step to changing it.
Accept that your tendency to close trades early is a natural response but not necessarily the best decision for long-term profitability.
#2. Focus on the Big Picture
Trading is a long-term endeavor; short-term emotions can lead to poor decisions.
Getting caught up in the moment and making decisions based on short-term emotions is easy when you're in a trade. However, trading success comes from focusing on the big picture. This means understanding that what feels good in the short term—like closing a trade to secure a small profit—can be detrimental in the long term. Successful traders learn to stay calm and follow their plans, even when things get tough.
Keep your eyes on the overall goal of consistent profitability rather than short-term gains.
#3. Prioritize Stop Losses
Stops are more critical than entries in determining trading success.
Many traders spend much time planning their entries and targets but neglect their exit strategies. However, the timing and manner of your exit can significantly impact your profitability more than your entry. Developing a robust exit strategy involves setting 'hard stops,' sticking to them, and using trailing stops effectively. By prioritizing your stops, you can ensure that you're maximizing your gains and minimizing your losses.
Develop a solid exit plan and stick to it to improve your trading outcomes.
#4. Use Price Action
Let price action guide your exits rather than arbitrary targets.
Relying on specific target-based exits can be problematic because market conditions constantly change. Instead, use price action to inform your exit decisions. For example, if swing patterns suggest that the market is still favorable, stay in the trade. Conversely, if it suggests the trend is reversing, it might be time to exit. This approach allows you to be more adaptable and responsive to market conditions.
Use objective signals to guide your exit decisions for better results.
#5. Manage Risk Effectively
Effective risk management is vital to letting winners run and achieving consistent profitability.
Risk management is crucial in trading. By managing your risk effectively, you can stay in winning trades longer and avoid the fear of giving back profits. This involves setting money management rules, determining position sizes based on expectancy, and monitoring your trades continuously. Proper risk management allows you to trade confidently, knowing you have measures to protect your capital.
Implement strong risk management practices to support your trading strategy.
By focusing on these areas, you can overcome the common pitfalls that prevent traders from letting their winners run.
Remember, trading takes practice and patience.