You already have this incredible trading tool – why aren’t you using it?

You already have a trading tool that can tell you when to close out a trade early … and when to let it run.

Yet, again and again we ignore this tool – because we’re told it would be ‘wrong’ to act on it.

I’m talking about your own judgement on a trade – that moment when you’ve spotted something in the price action that’s not right, or you’ve just got a bad feeling. Yet, we’re told that we have to stick blindly to the rules, no matter what.

So, what’s right? Rules? Or acting on the hoof?

Here’s how to combine the two, so you know exactly when to break your rules – if you do it this way, you can boost your win rate, AND reduce the size of your losses.

Okay, here’s a scenario I expect will be very familiar …

You’re in a trade that’s within touching distance of its target, but the price is sticking. Maybe you should have spotted this area of resistance when you placed the trade, but it didn’t seem significant then. It does now.

Should you take the profits off the table now? Or hold your nerve and wait for the full profit?

It’s really important to have trading rules – and to stick to them. Our carefully formulated trading method should be based on lots of lovely data from past performance. If we start making it up on the hoof … we’ll get into all sorts of trouble.

But, I’m about to contradict that …

The problem with our carefully measured rules is that they are based on average price behaviour over weeks, months, even years of watching market activity. But the reality is that live markets, in the here and now, don’t give a damn about what the law of averages says they should be doing.

An example we’ve looked at before in Trader’s Bulletin is the design of fighter-pilot cockpits. In the 1940s, the US Airforce investigated air safety, and found that their cockpits were still built around the average size of a pilot in 1926. Pilots had got bigger since then, so they set out to find the new ‘average’ to build a cockpit around.

What they discovered was that, out ofover 4,000 pilots measured, not one fitted within 30 per cent of the ‘average’ across 10 measurements taken.

The ‘average’ just doesn’t exist.

What the Airforce did was, rather than building the cockpit to the average, they built an adaptable cockpit, where seats, pedals and straps could all be adjusted.

And that’s exactly what we need to do with our trades – complete with ejector seat! While all that past data is hugely valuable, it’s only valuable to a point. We need to be prepared to adapt to each situation.

And the scenarios we’re working to can change quite rapidly too, meaning we sometimes need to radically overhaul our data.

There’s been a lot in the news recently about car safety systems, and how they’re all designed around the average male body – never considering that a woman could get behind the wheel! As a result, women are far more likely to be killed in car crashes.

We all need to be very wary or basing all our decisions on past averages. Conditions can change drastically. Our trading methods need an in-built adaptability, rather than a one-size-fits-all approach to our trades.

So, let’s get back to that trade that’s banging its head against resistance, just a few pips away from a win …

Can we take profits early?

What does it mean for our profitability?

And what does it say about our discipline as traders?

How taking early profits messes with your results

Any profit has to be a good thing, right?

Well …

The profitability of a trading strategy comes down to a fine balance between risk/reward and win rate. A lot of trend-following methods can have a low win rates, relying on the occasional big win to push them into profit. The bread and butter of these methods comes when the market makes those big swings, and we need to be careful not to miss them.

If the price is dithering, but still a long way off our target, I’d caution against snatching at those profits – it can seriously impact your risk-reward balance.

But when you’re close to the target, things are quite different.

Let’s say that we’ve taken a 1:1 trade. We have a profit target 50 points above our entry, and a stop level 50 points below our entry. Our trade is now 45 points in profit, and feels like it’s going nowhere.

When we took the trade, our risk was equal to the potential reward. Now, our risk is 95 points, and our reward just 5 points. This is a very uncomfortable place to be – and definitely NOT a trade you’d choose to get into.

So, why on earth do we feel that we have to tough it out?

We really don’t.

If you don’t like a trade you’re in, there’s no reason to feel that you have to stick with it. There are many reasons for getting out early – news events, price action, levels breached (or not breached), and even just a ‘bad feeling’ about it.

So, what’s the best way to make an early exit?

• The first rule is to have a plan – don’t just wing it. Think through the scenarios, and know what you’ll do.

• If the trade is in profit, still has a way to run, but you want out – consider tightening your stop, even locking in some of those profits. That way, you haven’t prevented the chance of getting a big winner.

• If your trade is showing a loss, and you don’t like the look of its potential, cutting losses early is a great way to boost your risk-reward ratio by reducing the average size of losing trades. Try to build some rules into your trading strategy for scenarios in which you’ll cut losses early.

• If you’re already close to your target … the price is halting and making you uncomfortabe … my advice is to just close out. And if you’re moving into a weekend, or overnight, when you’ll incur extra brokerage charges, the case for this is even greater.

That may surprise you, given all the banging on I do about trading discipline.

For those of you who follow my results on trading strategies, you’ll know that I never do this in my published results. The reason is that I’ve created the rules, and feel I have to trade to the letter of those rules for the benefit of my clients – otherwise I couldn’t maintain a track record.

But in day-to-day live trading scenarios, often it’s very wise to take profits rather than wait for the final couple of pips.

Of course, I’m not suggesting that we let our trading decend into some kind of undisciplined anarchy – but sometimes we need to be able to make decisions on the go. And if we see an opportunity to take a healthy profit off the table – no one should argue with you for taking the cash.

 

To enjoy more content and get it faster Follow @TradersBulletin