By Gabe Velazquez, Online Trading Academy E-minis Instructor
In the trading arena, managing risk is always job one. Along with this imperative, dealing positively with the inevitable losses that will arise from trading is another psychological hurdle for most traders to overcome.
The other terrific writers that pen newsletters for Lessons from the Pros have written extensively about these subjects. These topics deal with the challenges, and some would say the negatives, faced by those of us that pick trading the markets as our career; however, not much is written about how we deal with success.
Let's explore a scenario that happens far too frequently to not only day traders, but investors as well. The situation I'm referring to is one in which a trader or investor has cultivated a nice profit, but struggles to hold on to it. He's garnered those profits by executing his plan and exercising discipline. The challenge then becomes to not become overconfident and relax the rules of his strategy, or as is sometimes the case, become reckless in this situation.
Day traders: How often have you been profitable in the first hour of the trading session only to give it all back by the closing bell? Investors: How many times have you been sitting on huge profits in your portfolio only to see those evaporate in the bear market?
Below is a terrific email I received last week from a student who has been working very hard transitioning herself into a full-time career in trading the E-mini futures:
Hey Guys!
I just wanted to tell you I took 3 trades this week: 1 Wednesday for 5 points, 1 this morning for 5 points, and 1 in the afternoon with 2 contracts (which was the plan if I was up by a reasonable amount -- 2 point risk in total) for 6 points! My day net is $887 and my week net is $1054!
I wrote a statement from Think and Grow Rich (I had a $2k target for the end of the week), read it every night and every morning, and just focused trading the plan and moving forward (instead of saving money, which I was doing prior).
Anyway, thank you so much for the help and support. I can't tell you how much it means to me.
I'll keep you posted on everything. I'm going to try not to think about this too much, but I'm so proud of myself!
Have a great weekend and week!
A.
You get the sense from her writing how extremely excited she was about the banner week she had just experienced, and deservedly so I might add. She works very hard at bettering herself as a trader, by asking a lot of great questions and making the proper adjustments to gain profitability. She is consistently seeking information that will help accelerate her learning curve, and as we can see from the results, it seems to be paying off. I responded by saying that I was thrilled for her success, but I also added that she must maintain the discipline that got her here. This was meant to keep her in check and prevent the mistakes that may happen with overconfidence.
One way to prevent success from making us lose our focus or discipline is by having a give-back rule for when we achieve our profit targets on any given day. It works as follows: Let's say that our daily goal is $500.00, and we achieve that profit target in the first two hours of the trading day. This rule allows us to continue trading - with one stipulation - that we cannot give back more than 30% of the gains. This allows us to continue trading for the day until we've reached the next benchmark, or give back 30% from a new high watermark. It's like a mental trail stop that is designed to prevent overtrading and conserve the bulk of the profits for the day.
Another rule that might help investors in this regard is to have the same draw down rule for the overall portfolio once a yearly benchmark has been attained. In this instance, a 7 or 10% rule may be imposed, whereby if the overall value of the portfolio drops by the specified amount (from peak to trough) in any given month, you pare down the ownership of stocks by 80%. The 20% allows for those positions that may still be profitable to stay in the portfolio. This may seem extreme, but I can tell you that many successful hedge funds implement similar rules in the way they manage their client's money.
The bottom line is that as humans with emotions, we have a tendency to become complacent when things are going well. In trading, we have to guard against becoming too excited when profits are piling up, just as we shouldn't become overly depressed when we go through bouts of losing. Practicing humility is a good start, along with having rules in place that will aid in retaining the lion's share of our profits that we work so hard to achieve.
Until next time, trade well.
If you have questions or comments, please email me at gvelazquez@tradingacademy.com
- Gabe Velazquez
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