Cut Losses Short - Trader Psychology

We all know (hopefully) to cut losses short and let winners ride is a make or break concept that will determine whether or not a trader can come out ahead in the long run.

If you didn't know this before, you do now. You can work on this concept now, or you can go through a lot of painful losses to figure it out later, the choice is yours.

On top of that, finding out how important this is later may be at the point when you have no more money left to trade. So I highly recommend not waiting any longer.

I have another page on this topic here: Cutting Losses Short that gives a brief example of how this can effect trading results.

The page you are on now will take a brief look at the trader psychological aspects involved.

Here is a common scenario a stock trader will find themselves in:

The trader has a string of winning trades. Let's use 5 profitable trades in a row of $100 each. These 5 trades only had a maximum drawdown (maximum amount of unrealized losses for the duration of the trade) of $40.00 each and then moved higher. Profits were taken at $100 in each trade for no other reasons than because they took less than an hour each to make, and the trader thought that was great.

The sixth trade initially goes up, with an unrealized profit of $50 and then starts moving lower. The trade continues lower and the position is now down $50.00, then $100.00 and keeps moving up and down, but trending lower. At this point the trader should know to cut losses short and exit the trade, but doesn't do so.

As the price continues lower, if the trader has a stop loss in place, whether mentally or physically, they keep moving it further and further away. Since the stop loss isn't hit, it's not a loss, right? Sorry, but this is the wrong thing to be doing on a losing trade.

While this is happening, things start to go through the traders head like "the previous 5 trades in a row were winners, if I hold this one longer I can make it 6 in a row", or "I'm up $500.00 on the previous 5 trades so I have room for this one to move lower and still come out ahead", "this can't keep going down, sooner or later buyers will step in at this price", or how about this one: "I can't sell now, I'll lose money on this trade".

Then you will have some people say: "if I double my position at this low price, then my cost will be less and my breakeven point will be lower". What winds up happening is that the $500 in profits from the previous 5 trades ends up being lost because the losing trade is held way too long. Many times, the original profits from previous trades are lost plus additional losses on top of that.

The list of reasons/excuses can go on and on. There is always a reason/excuse why we cannot close out a position that is losing money and cut losses short. Many times we have a profit target in mind before we enter a trade and once obtained we stick to it and close out the trade right away. The same must hold true for a losing position, no questions asked, just close out the position and look for the next opportunity.

Time and brainpower would be much better spent on managing a profitable trade or looking for the next trading opportunity than to think of reasons why we can't close out a losing position.

When setting up your trading plan with rules and guidelines, make sure you come up with an exit strategy before you even think about entering a trade. This of course will not guarantee that you will follow your plan, but it is a step many people don't put any effort into at all. Learning to control your emotions and apply strict discipline in each trade will be the key to being able to cut losses short.




Return From "Cut Losses Short- Trader Psychology" To "Stock Trading Risk Management"


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