By now I’m sure you’ve heard that the two main emotions that enter into trading are fear and greed. Experienced traders accept that losses are a cost of trading.Tweet: 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!
Written By Rick Wright, Online Trading Academy Instructor. Rick Wright’s goal as an Online Trading Academy Instructor is to accelerate the student’s learning curve, whether they are interested in High Frequency Trading or Investing for Beginners. He teaches classes on Online Stock Trading, Forex Trading and Futures, among others. Rick studied economics and psychology at Iowa State University, and entered into the brokerage business in 1992. He earned the NASD Series 4,7,9,10,24,55,63, and 65 licenses. He helped grow an online brokerage business which was eventually sold off. Rick has also held positions as broker, branch manager, and several VP positions in the brokerage business. Rick began trading equities in 1997, and was introduced to the Forex market in 2002. Currently trading from home in Dallas, Rick is also a frequent contributor to various TV and business talk radio shows. In his articles, Rick will show you several examples of trading mistakes that he and others have made, which cost thousands of dollars in the past so you won’t make the same mistakes. You will learn how to recognize the differences between long and short term trends, where to enter trades, and where to exit based on previous price action.