Cut Your Losses But Let Your Gains Run

Whatever markets you trade and whatever timeframes you use, you will frequently get your trades wrong. Even if your model tells you there is a 90% chance of success, the 10% will occur.

Broadly speaking there are two ways to make money trading:

1. Sniping (sometimes called Scalping)

Take high probability trades (70% or above probability that this particular trade will be successful). 

When sniping you need to take profits regularly.

Day traders are usually Snipers.


2. Trend Trading

Take low probability trades (under 50% probability of success) but where the losses are small but the profits on the winning trades are large.

In scenario 2 you cut your losses quickly but you let your gains run until such time as either:

(a) The trend changes; or

(b) Your analysis leads you to change your view.

Medium to long term traders are usually Trend Traders.


I am a trend trader. The only way to make money over a long time period trend trading is to
limit your losses and maximize your gains.

One of the best ways to ensure this is to:

“Cut your losses but let your gains run.”

Too often traders hold on to losing positions hoping they will turn around. Even more often traders will take a profit and then watch with dismay as the market keeps on going in the same direction and they miss out on much larger gains. I have been guilty of both of these mistakes.

There is also a simple way to let your gains run – using a trailing stop loss. See the page www.TradingBook.org/stop-losses.

Break Even

I can always tell a novice trader. They are concerned with breaking even on a trade when the trade is losing.

Critical Principle – Breaking Even is a Terrible Strategy

Breaking Even is a terrible strategy for two reasons:

1. If your entry point was correctly set at the break of a key support/resistance level it is almost certain that the market will come back and test the support/resistance level. A mistake most novice traders make is that once they are onside with a trade they will move their stop loss level to break even. Then the market return to that level taking out their stop, and immediately turns around again and goes in the direction of the trade. It is times like this that the novice trader thinks that “the market is out to get them”. No, it is simply bad trading.

2. The only one solitary reason why traders want to break even when they are carrying a losing trade is ego. If you can only break even you can walk away feeling like you didn’t lose. So what?

If you are 50 points offside on a trade and you no longer believe in the trade cut it immediately. Holding on for it to move 50 points in your favor is blind hope and most of the time it doesn’t happen. You have to get to the place where you are happy walking away with a small loss. Because a small loss more often than not turns into a big loss, and that really hurts.

And practically what does breaking even matter? In a month’s time you won’t even remember your small losses and your profit/loss statement will barely show them. But a big loss caused by trading because of your ego will stay in your memory and in your profit/loss statement all year.

One of my greatest strengths as a trader is that I think of losses as Cancer. The quicker I remove them the healthier I will be. I don’t sit around and hope that the Cancer will heal itself. I operate immediately. Now that doesn’t mean that every time I am offside by 20 points I cut my position. But it does mean that before I even enter a trade I have my stop (exit point) in place. I never move that stop unless it is to protect profits. Also if I have a trade that does not do what I expect it to and I am holding a small loss, I will cut the position and wait for something I do believe in.

 

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