Cutting your losses fast and letting your winners run is a common phrase we hear all the time. Yet applying this simple strategy to your trading can be harder than it seems.
The first thing is that many of us find it hard to admit when we are wrong. As kids we were disciplined and corrected whenever we made a mistake. Whether it be by parents, teachers or peers. We associate being wrong with an unpleasant experience, and therefore avoid it at all costs. We were never taught that being wrong is Ok. That the experience is a lesson and something to learn from in the future.
So in trading when a trade goes against us, we start justifying things rather than admitting we were wrong. For example, the voice inside our heads might tell us to buy more of a losing position. After all, the stock is cheaper now than when we originally bought into it.
There is a flip side to this as well. Some traders take profits too quickly. The fear of losing is too great so a quick profit is better than nothing.
The premise for both behaviours though is the same – a fear of being wrong.
The ability to avoid bad trading behaviours can be the difference between success and failure. Yet it’s a conscious practice that needs to be affirmed into your daily trading routine. So it becomes automated and ingrained over time.
When to cut and run from a trade should not be a subjective decision. It should be an important part of your processes aligned to discipline, controlling your emotions, and mitigating risk.
It’s a good idea to frequently check in on yourself as well, to see if you have reverted to any of your bad habits. Have you started to average down into losing positions? Have you fallen in love with your stocks, or fallen in love with a management team? Are you using excessive margin? Are you focusing on too few positions or a narrow range of sectors? Are you trading too many stocks at the one time? Are you investing in stocks that lack liquidity? Is your ego getting the better of you again?
All these bad habits can affect the way you make decisions about when to stay in positions, and when to cut and run and move onto the next trade. Keeping tabs on your behaviours needs to be an integral part of your strategy.