The Internal Conflict That Trading Can Create

The Internal Conflict That Trading Can CreateI work with traders every day. I help my students to trade stocks more consistently and more profitably. And in my day-to-day interactions with them, I notice some of the same things again and again.

Recently, I found that most traders are good at following their rules and minding their setup conditions, but are not so flexible in their thought process. These two aspects of trading put traders in direct conflict with themselves because though they may be following their rules as unemotionally as possible, they still need to have some judgment and need to know when their rules should be broken.

Many people believe that the markets move in a completely random way. Although it may seem chaotic, the longer you watch the markets and look at charts, you find is that a market is actually a series of repetitive patterns that we as traders are trying to recognize as early in their development as possible.

That being said, we will not always recognize the emerging or developing pattern as early in its development as we would like. This may largely determine if a trade is successful or not. We also need to be flexible enough in our thinking to recognize when we are just wrong. There is nothing bad or wrong about being wrong, but there is something wrong with trying to force the issue. You pay for that with losses.

By its very nature, trading in an open market lends itself to the need for flexible thinking. For example, we may move our stops to a tighter position if we know of an event, possibly international economic news or company earnings announcements that will likely affect the market. But too often I see traders turn a blind eye towards these events; such lack of attention can really hurt the value of their accounts.

A good example of this can be seen in the following chart. It’s of a Forex trade that I was involved on the morning of 5/3/2012. I entered the trade short at approximately 5:30am US EDT on the candle with the downward arrow above it. My stop was the top horizontal line and my profit target was about 50 pips below my entry point, which is off the bottom of the page.

At 7:45am US EDT the Euro zone interest rate announcement came out; I had known about this in advance of this trade. It had a nominal effect on the price action largely because there were no surprises; no market correction or adjustment was necessary.

What did have an effect on the price action was the US Unemployment Claims report that came out at 8:30am. It came out better than expected, so there was an immediate correction to the pricing. The pair jumped up at first, which made me believe that I may be stopped out. But then it dropped like a rock and bounced around with a widening spread. I manually exited the trade where the bottom horizontal line is booking the profit; then I moved safely to a cash position.

The Internal Conflict That Trading Can Create

The point is that this trade did not necessarily go as planned. I did not rigidly stick to my trading rules and did not try to force an outcome. I realized that there is never a bad time to book a profit. If I did not exit the trade when I did, a few minutes later I would have been stopped out with a full loss on my entire position.

The take away here? Trade management is important. In this case, two small changes were the difference between having a profitable account versus an unprofitable one. If we tighten our stops when a trade is in the money, and if we are quick to exit a trade if it appears as though the price action may turn against us, we make and keep a profit.

Generally, winning trades are easy to manage simply because we are on the right side of a move so there is no need for us to do anything. But managing a losing trade is where we can have a huge impact on our accounts. If we manage the losing trades to reduce losses on some and possibly eliminate others altogether, that will have a greater impact on our profitability than having more winning trades.

It is always nice to have more winning trades, but if we reduce our losses by 10% or 25% or 50%, this reduction in losses would likely have a much greater impact to the bottom line over time than anything else we can do with the same effort. The good news? Reducing losses is not that difficult to do. Make it a priority and you’ll find you keep more of your profits and minimze your losses.

Profitable trading,

Bill Poulos

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