“If you want to make money from trading forget about making money!”
We spend a lot of time as traders focusing on trade entries.
I suppose there is some logic to it. After all, until you get into a trade you can’t record a result.
But you’ll probably notice another part of the process demands just as much attention, probably even more!
And that’s when it comes to exiting your trades.
Our two greatest adversaries – fear and greed – can run you ragged here if you’re not careful.
Fear can have you on pins. As soon as your trade shows a small profit the urge to cash-in your chips can become almost unbearable. And cutting profits short on a regular basis can be fatal to your campaigns.
Greed on the other hand can have you overstaying your welcome.
This feeling tends to grab me when a trade starts out particularly smoothly – when it runs in an ‘almost too good to be true’ fashion.
The market might have moved strongly in my favour from the off, the profit target looms just a few pips away, and suddenly I’m torn…
Why take profits here? That all happened so quickly there’s bound to be more movement still to come!
And it can be a particularly bitter pill to swallow when you cancel your profit target, hoping for more, yet watch all those ‘easy’ profits turn into a loss instead.
Thankfully there are simple and easy ways to feed the greed. You can close 50% or 75% of the trade at the intended target and leave the rest working. This way you’ve managed your exposure on the trade and you still get to play a part in any bigger momentum move.
It’s that nasty business of cutting profits short that needs our most urgent attention!
So today I’m going to show you two little tricks that helped me overcome this exact problem.
They’ll be useful for you to know because cutting profits short is one of those paradoxes we must overcome as traders.
What would otherwise be classed as an act of self preservation in the ‘outside world’ can have the exact opposite effect in the markets.
After all, I’ve very often heard traders say things like “you can’t go broke by taking a profit”. But I disagree…
I think the key factor is how much money you might be leaving on the table by bailing out too early. Leave too much behind on a regular basis and it can seriously impact your potential results!
And the only way to overcome ‘the urge’ is by overriding the natural emotions you go through when your trade first shows good profits.
But do remember, it’s just your ape-brain trying to take control. It does have your best interests in mind, even if it’s a little misguided. It’s sending you an urgent message:
You’ve found something good, take it. Take it now, before you lose it!
Now those instincts served your caveman ancestors very well. Every bit of food they had the good fortune to stumble across and stash away could be the difference between life and death.
Problem is, evolution has been slow to change the way our brains are wired. And to really maximise success in the markets we need to adopt a more controlled exposure to risk.
I must give fair warning though – these two methods are not for the faint of heart.
They’ll both stretch a trader’s comfort zone as the pathway to allowing trades to fully develop. So if you do try them out, please make sure you don’t go risking anything over and above your own personal trading limits.
Method 1: Always have a position in the market
So the first thing my mentor had me do when we were working on this aspect of my trading was to take a one-contract position in the market and never be flat.
I could change direction as a saw fit. For example, I could be long all morning and then flip to a short position if I thought I detected a change in trend. But I could never be completely out of the position.
The exercise lasted for two weeks. I was learning to trade T-Bond futures which moved at $32.50 per tick but for this exercise he had me take a position in the Mini Dow futures which ticked at $5.00 (less risk but still with real money on the line).
And this was all about getting over the tendency to focus on trading for profit.
Sounds a bit backwards doesn’t it?
But if you focus on getting yourself in tune with the ups and downs of price, the profit will inevitably follow.
Again, it’s one of those odd trading paradoxes: if you want to make money from trading, forget about making money!
Get yourself to do the right thing at the right time and the money will look after itself.
And I’ll tell you what, watching the price action develop when every little flicker on the screen makes or loses you $5.00 – especially when you know you can’t avoid it – has a way of gripping your attention like nothing else!
You start to notice little quirks and characteristics of the market because you are financially committed and fully involved. These are things you probably wouldn’t pick up on if you were casually observing your charts with no stake invested.
(NOTE: If you did want to conduct a similar exercise yourself, the micro lot Forex contracts can let you have a go for pennies per pip.)
So once we’d been through the mill with the first exercise we were relieved of the requirement to always be in the market. We could then actually choose when to enter and exit our positions!
It was then time to look at method 2…
Method 2: ‘Pyramid’ your way into the trade
This time, you could choose when to get into a trade, but when you felt a premature urge to exit the trade, you had to double up instead. You bought a second contract, adding to your position.
And you know what? Very often the trade rolled on into super-size profits. Put yourself through that initial pain-barrier of going against your instincts and you’d often see four or five times the return you’d have gotten if you took the first ‘scared-money’ exit.
Now this technique of adding to a winning position can be developed into an essential part of your trading toolkit.
It was Jesse Livermore’s secret weapon. He was the incredible trader characterised in Reminiscences of a Stock Operator. Also known as ‘The Boy Plunger’ for the huge positions he ran from a young age (he started trading aged 14).
Livermore called his scaling-in technique ‘pyramiding’…
Now imagine an upside-down pyramid. In fact, here’s a diagram:
What Livermore did was to identify a potential turning point in the market and make his first entry (a small test trade) when the market explored that price area.
Next, if the market showed the intention to carry on moving as anticipated, he might double-up his position. In the pyramid diagram above, the market moved upwards proving the analysis to be correct so more contracts are added at the second entry.
The market carries on upwards, more contracts added at the third entry…
Until eventually the new direction of trend cannot be disputed and the full position is loaded-up.
You might even be able to get a stop loss order working at break-even level for the whole position at this point.
The beauty of this technique is that you are almost never heavily positioned when a loss is incurred. You can happily let the market prove you wrong at the first entry stage multiple times because you know it’s only a matter of time before you are rewarded with a trade that snowballs into massive profit.
I don’t know about you, but it makes so much sense to me to scale into a position like this. You can take things cautiously, letting the market prove your judgment correct with hard cash.
And the profits you start racking-up can then fund the purchase of your later additions to the trade.
Jesse Livermore certainly found it to be effective… his only problem was actually keeping his hands on the vast sums of money he made!
So would you agree that’s a smart way to manage your big-money trades? Give it a try and let me know what you think.
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