Hello traders! This week’s newsletter was inspired by a very common new trader problem; that is, trading with fear.
By now I’m sure you’ve heard that the two main emotions that enter into trading are fear and greed. In my last Professional Forex Traders class in beautiful San Diego, a student mentioned to me that one of his common trading issues was taking profits too soon. In my humble opinion, this is a lesser known symptom of trading with fear, the fear of losing.
Experienced traders accept that losses are a cost of trading. If you struggle with a fear of losing, you may be trading larger position size than your account/heart/stomach would allow. In every forex class that I teach, I recommend starting with a risk of .5% of your account. With such a small percentage, your initial fear should be minimized. As your experience and confidence builds over time, I would expect this risk percentage will increase to 1%, 1.5%, even up to 2%. Don’t be too aggressive and go about risking 10%, 20% or more of your account on a trade! That trading adventure will be very short!
There Are 5 Possible Trade Outcomes
There are five possible outcomes to any trade: A large loss, small loss, flat or break-even, small win, and large win. When you eliminate the large losses by using stops properly, we expect the small losses and small wins to cancel each other out, leaving you only large wins. Sounds easy enough, right?
Here is the problem: many traders get into the unfortunate habit of closing their winning trades too soon, before the move is done. Why would they do this? The reasons are varied but two stand out to me.
Why Traders Exit Trades Too Early
The first is that they have watched a trade go profitable, say $200. Then, as the currency pair pulls back to where the trade is only up $50, the trader will often be afraid of missing out on any profit at all so they will quickly exit the trade. Guess what probably happens next? The trade very often goes to their profit target without them along for the ride. That fear of losing caused them to miss out on profits. Has that happened to anyone else? Because I know it has happened to me before!
Another potential “reason” this trader may be taking small profits out of fear is they have seen a small gain turn into a small loss when the price hit their stop loss. There are two things to note about this issue. If price hits your stop and then reverses toward your profit target, your stop might be in a technically silly location. What constitutes a silly location, you ask? When going long, we recommend that you enter your trade at a quality demand zone, and short in a quality supply zone. Your stops should be a few pips below or above the zone you used for entry. It would be the rare trader indeed who can consistently make money with a 3 or 4 pip stop loss! The second thing to note is the trend you are trading with. If you are a counter-trend trader, you must be quicker to move your stop to break even than a trend follower. Counter trend trading is harder and requires more effort. I prefer easier and less effort myself!
Remember the five potential outcomes? If you consistently exit your winning trades too early out of fear of losing profit, guess what happens to your big wins? They don’t exist, that’s what! You might not be losing money as a trader with this strategy, but your probably aren’t making good money either. New traders often quit because they just aren’t making enough to continue to trade. So we need to fix this problem.
The Solution to Exiting Trades Too Early
There are two things that I recommend in class to help with this issue. The first is to trade in the direction of the trend. You can use a trendline, moving averages, or just the pure price action to determine the trend. Trading with the trend definitely helps the big wins happen! The second recommendation is to stop staring at your screen when you are in a trade! If your plan was to be in this trade for a couple of days, yet you are watching the one minute chart, you are doing it wrong! If watching every couple of pips go against you makes you fearful of losing profits, step away from the screen for a couple of hours at a time so you won’t be tempted to exit a winner too early. (You should still check your charts occasionally to see if you need to trail your stop, of course!)
I hope these simple suggestions will help with your “trading with fear” problem!
Until next time,
Rick Wright – firstname.lastname@example.org