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Article Patience in Profit Taking by D.R. Barton, Jr.
Trading Tip Managing Your Emotional Bank Account by Ken Long
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Patience in Profit Taking
PATIENCE, n. A minor form of despair, disguised as a virtue.
Have you ever had a problem, and you didn’t realize that a simple solution existed until someone else pointed it out for you?
In past articles, I’ve mentioned my son Josh’s affinity for golf. Earlier this year, he was working on a problem with his swing that kept him from hitting the ball as far as he should be. He was ending his swing with his hips not fully turned toward the hole, and his head still facing down a bit.
Josh worked with a couple of high-end golf pros on exercises to clear his hips and help him “finish” his swing properly. And while some of the drills were helpful, they never cured the issue.
Then, in one seemingly miraculous lesson, a local pro showed Josh exactly what he was doing. Despite having a very nice swing, he wasn’t turning his head so he could follow the flight of the ball with his eyes. This in turn was keeping his head anchored down, looking where the ball used to be. With his head staying in place, his shoulder, torso, and ultimately his hips were restrained from finishing the swing.
Within five minutes, the new pro had Josh’s eyes and head turning up and watching the ball fly toward the hole, which led the rest of his body in to a beautiful follow through.
It was something so simple, and now, in hindsight, so clearly obvious. But Josh couldn’t solve the problem without having someone look at his swing from a fresh perspective.
This week, I noticed the same situation among the traders I was working with. It is very difficult to see the solution to your own issues, but an experienced outside view can often identify those problems quickly and easily.
Many Issues, Universal Solution
As I debriefed trades from many different traders this week, common themes appeared. The first and foremost was a consistent bias for taking profits too quickly. The second issue was moving stops up too tight and too early in the trade. As it turns out, they are quite closely related.
Both issues have to do with a fear of giving back profits. (That’s a blatant case of stating the obvious.) At a deeper level, both issues—taking quick profits and trying to move a trade to breakeven too quickly—have to do with needing to be right about the trade.
And fortunately, both issues have the same solution: exercising the patience to allow the trade to develop. That patience is most easily found by putting together a trading plan that clearly describes where profits will be taken and how (and if) stops will be trailed in the direction of the trade.
If we step back and take an objective look, we can see that taking profits too quickly violates the golden rule of trading—cutting losses short and letting profits run. But in the heat of battle, it’s easy to forget even the most basic of rules.
On the issue of moving stops to breakeven, I believe that most newer traders trading counter trend systems will be well-served to have a static stop that stays in place for the duration of the trade. Learning to allow a full move to the profit target or to the stop gives you the freedom to let the trade work. It also minimizes the possibility of the position getting taken out by normal retracements, or the noise of the market.
There has been some good research over the years on the effectiveness of moving your stop to breakeven; research shows that it actually hurts profitability in the long run. In my article next week, we’ll look at this research on breakeven stops and the implications for traders of different styles (trend followers, counter trend traders, etc.).
In Jack Schwager’s New Market Wizards, William Eckhardt (of Turtles fame) said that one mistake traders make is putting too much importance on any single trade. His suggestion was to remember that any one trade is just a small part of the bigger picture and needs to be treated dispassionately. When the individual trade becomes too important, we tend to do things to make the trade work (e.g., we take profits too quickly or we let losses go in hopes of a return to profitability).
This brings us back to patience. A friend who was a floor trader and moved to a successful career trading at the monitor found that he had to literally distract himself to keep from over-analyzing and over-managing trades. We can achieve the same result by developing a strong set of trading rules and then letting that system guide our entries and exits. Then we can transfer the responsibility for trade outcomes to the system. This removes our ego and our need to be right—the very things that cause us to take profits too quickly. Relying on the system’s rules is the easiest path to practicing patience in our trading. After entering the trade all we need to do is wait for our exit rules to take us out, whether that’s with a profit or a loss.
Once we’re in a trade, it seems that patience is indeed a virtue.
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Managing Your Emotional Bank Account
Managing your intraday trades when the market is open can very nerve-racking. Sometimes there’s so much going on that it’s hard to keep track of what’s important. Other times it seems like you’re watching paint dry and nothing is going on. You can feel your nervous energy building up in an urge to do something.
This sense of market condition affects your trading state of mind, as does the sum total of your emotional responses to the results of the trades that you have taken so far that day.
It is as if you have an emotional bank account that tracks the debit and credit of your emotional responses to the results of the day. After a couple of losing trades in a row, it would be natural for you to start experiencing a bit of anxiety with respect to the remaining open positions to get back some of that positive feeling associated with momentum and profits.
If you can feel your emotional state varying as a consequence of the trade results for the day, then it is a good idea for you to reinforce your trading practice. This gets you to the “zero state” quickly and easily as soon as you can sense your emotional state changing.
If you are an intraday trader relying upon tight stops to catch key turning points in the market to create high reward-to-risk ratio trades, you must come to expect a series of minor losing trades in a row in order to be positioned to catch the winning trade that will buy them all back and then some when the trade takes off.
If you have unreasonable expectations about your win rate, you may find yourself becoming depressed by a losing streak that should be considered normal. Knowing your system and the way it performs will help you resist the emotional drain of the losing trades that are within the normal distribution.
In addition, trading techniques like getting to a “no lose” condition quickly, staying in tune with market cycles intraday, and being ruthless about banking some wins when you have them in hand can help you develop the emotional thick skin to be able to manage trades that go against you in a professional manner.
If you find yourself reaching for the next trade, or getting nervous about looking for the next opportunity to get you back to your winning ways. This indicates that you are not trading from an emotionally balanced, stable and secure base.
The more your trading relies upon your discretion and judgment in the moment (a common feature of intraday trading), the more important it is for you to monitor your intraday emotions.
Include your emotional state in the evaluation checklist you use on each trade. This way you can ensure that you’re coming from a place of emotional, psychological and intellectual stability rather than entering a trade as a response to a decaying emotional state.
Monitor that emotional bank account!
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Q: Stops have been quite bothersome for me. I’ve talked with and read from a few ex-Market makers, and they’ve shared how they take out stops and why. I’d love to hear about any methods you or fellow traders use to protect your stops from being taken out. Joe
A: Recently, I was surprised to read a highly negative opinion on stops from a longtime market analyst whom I respect. He recommended using no stops at all, which I would find simply impossible to do. I've also come to learn through experience, however, that I used to set my stops too tight. From conversations with some more experienced traders, I found that's a common problem for novice traders. The typical prescription is to lower the position size and set your stops wider. As for the market makers, their job is to move the price towards liquidity. A lot of people tend to put stops in fairly obvious places (like a penny less than a swing low), and the market maker moves the price there if it helps improve liquidity. If you set your stops a little lower than an obvious point, you might be better able to stay in the position. This, however, is dependent on your method and is also, of course, a trade-off with greater potential losses. R.J.
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