While traders frequently commit an inordinate amount of time to selecting, planning and executing new positions, they often make the mistake of exiting these trades with much less thought. This is unfortunate as it is the exit, after all, that will determine whether a trade has been profitable or not.
This is where the traders’ enemies of hope, fear and greed make an appearance. It is human nature to grasp quickly at profits (due to greed) while the fear of incurring a loss will see the same trader leaving poorly performing positions open in the hope that prices will move in the desired direction and reduce losses or even see them turn into profitable trades.
There is an old saying among traders that you should, ‘Let your profits run and cut your losses short’. In other words, if you have a profitable position, you should allow that trade to achieve its full potential, rather than closing it out at the first sign of (a small) profit. On the other hand, if you hold a position that is moving against you, you should move quickly to exit that position, before the loss becomes too great.
If you are managing your trades correctly, your average profitable trade should be considerably larger than your average losing trade. Once you have the discipline to trade in this way, you should be able to achieve overall profitability even if only half of your trades are profitable.
Many traders make the mistake of not closing poorly performing positions quickly enough. One tool that makes this easier is the stop-loss order.
Once you have identified a price level that corresponds with the level of risk that you are willing to take on a particular trade, a stop-loss order can be placed at this level to automatically close out the trade. This removes the human element from the exit, reducing the risk that the emotion of hope will interfere with rational trading decisions.
It is important to understand that a stop-loss order simply provides a trigger point for the execution of an order. If a sell stop has been placed on a long position, the stop-loss will be activated if price trades at or below the nominated stop level. From time to time, this can result in trades being executed at a price that is less favourable than the nominated stop-loss price. This is known as slippage and can arise when prices “gap”.
Many traders make the mistake of not closing poorly performing positions quickly enough. One tool that makes this easier is the stop-loss order.
