The Art of Cutting Your Losses, If You Want to Be A Funded Trader
When your day trading strategies show a perfect trade setup, but for a moment you hesitate and miss the opportunity. You tell yourself “Getting in late is better than never!” and so you jump into the trade, late. By jumping in late you might have taken a higher risk. If your risk is out of whack your position size may be too, and your target may not appropriately compensate for the risk. it is vital to know when to pull out of a trade. Cutting your losses might just be the best trading decision for the day.
Cutting your losses may be difficult but it’s better than building a fighting instinct that doesn’t work. Remember that you are going in with the intention of making a profit so stay away from rash decisions. It starts with a rationalization that makes you abandon your trading plan, and instead do something random. Rationalization comes in many forms and it only leads to huge losses. Here are some reasons you’ve been self-sabotaging your trade.
Your Success Can Get You Funded If You Follow a Proven Method:
Great traders are simply excellent system followers because they practice, sometimes even on a market simulator. Consistently profitable traders have found an edge and they exploit it repeatably. Not by doing random things, but by following a method they have practised hundreds if not thousands of times under different market conditions. successful traders win every day because they know cutting your losses works. They follow their system for profitable day trading no matter what pops into their heads telling them to do otherwise.
Most rationalization traders think they don’t need a system because they are great traders. They believe they can make money acting on impulse, on their wits, instead of following a proven trading plan. This may work for a time, but these traders don’t last. when you abandon your trading plan, you never consider cutting your losses, and every action is taken on impulse.
Only take trades you have practised hundreds of times getting into and out of. Don’t take a trade because you think you are a pro. You have no plan for how to handle this trade, and no data that indicates what you are about to do has a statistical edge, then you better off finding the best stock market simulator available and trading on that until you gain an edge. Or you can consider cutting your losses when you are stuck.
Rationalizing to prevent cutting your losses
We just discussed not trading outside of your tested and practised trading method. Market analysis, market conditions, and the market environment will often make you want to deviate from this rule. Assume it is a very active day, with lots of price movement and volume. Within a few minutes of trading, you’ve already taken several valid trades. This is more than normal, but the market is producing the signals.
You start to get into your own head and think “This could be a life-changing day!” Depending on how you react to that statement you may take fewer trades going forward than you should because you are afraid of blowing it, or you take more trades attempting to make more money than the market allows. Your focus has moved from trading to something else. You are no longer focused on just finding valid setups, now you are rationalizing taking more or fewer trades than you should.
Your greed or fear is going to start shaping your trading decisions, instead of your system, thus cutting your losses becomes a problem.
A boring day can also lead you to take an invalid trade, simply out of boredom. You may convince yourself that you can still save the day and before you know it you’re in a random trade, gambling to make a profit. Cutting your losses becomes too late and you end up going home without a win.
Keep focused on finding valid trades while trading. Let the market conditions and your trading system determine when you trade, not your greed, fear or rationalizations.
Rationalizing to Stay in a Trade or Get Out
Every trading strategy must have an exit point. If you don’t know how to get out of your trades you have missed the most important step in creating a winning strategy. The exit is where profits and losses are taken, so when you take a trade you should know exactly how you will get out. Once this is established you may still fall into traps.
In a losing trade, traders will often come up with reasons for staying in it. You may tell yourself “I probably should have used have a larger stop loss based on the conditions” and so you feel justified in expanding your stop loss and taking on more risks. Or you may find some piece of evidence to warrant staying in the trade: “That indicator is at an extreme level so the price will likely move the other way soon.” The problem is that you are changing your strategy mid-way through the trade.
Why have a strategy at all if you can change it at will? If the strategy says to get out, get out, no matter what reasons to the contrary pop into your head.
Most new traders also have a problem with staying in winning trades. They feel compelled to make a profit as soon as it materializes and the mind is more than happy to come up with a rationalization for doing so. “Can’t go broke taking profits” or “Conditions are tough so I best take what I can get.” And just like that, you are out of the trade with a tiny profit. That tiny profit will do nothing to cover any losses which will inevitably come along. You can go broke taking undue risks instead of cutting your losses.
There is no escaping it. If you want to be successful you need to follow a plan with an edge. Stick to that plan, no matter what if you want to make a living out of day trading stock.
Also read: Is Paper Trading Right for You?
Dealing with Rationalizations- Cutting your losses
There is no easy way to overcome rationalizations. Rationalizations will sabotage you constantly while trading. The only way to handle them is to ignore them and focus on your plan, analyze the stock, and execute on a paper trading platform if you have to. They won’t go away though, they often just become more covert. Your primary defence is to practice your day trading technique by following your plan and executing it perfectly in spite of rationalizations to the contrary.
You may also find it helpful to write down all rationalizations that occur while trading. Go through the list and mentally rehearse what you will do when thoughts like that pop into your head. In this way, you are prepared, and rationalizations will have little power in swaying you away from your trading plan.