Let Your Profits Run! Cut Your Losses Short!
How many times have we heard these two sentences? Rules that support these concepts are difficult to follow with discipline, regardless of the style and trade strategy. Emotions take control and convince our rational mind that “the equity MUST have corrected all it’s going to correct” or “I’ve got a nice profit, but it doesn’t count as a profit until I close the trade” prompting us to abandon our rules that we set to govern our actions. Before you know it, that equity that seemed to have found bottom, drops further in price. Alternately, you may close your profitable position prematurely, only to see the strategy instruments continue to gain in value, luring you to get back into the trade at a different risk/reward ratio.
Rules that are established as guidelines to protect ourselves from large losses, and other rules that allow us to take full advantage of the move, are as individual as each of us. There are some general ways to start with this main category of rules-based-trading in order to build your personal rules that support your trading style and risk tolerance. At OptionsANIMAL we call this important concept “setting primary and secondary exits before the trade is entered.” The rationale behind these trade exit targets comes down to emotional control of Greed and Fear. We limit our losses to a reasonable risk and we take our target profits at a healthy percentage ROI.
By incorporating the habit of documenting the trade plan before you take the position, you establish a good understanding of where you’re going and how you’re going to get there. This habitual record keeping will not only guide you in your current open trades, but will also serve as your database of information you can use to learn what you are doing that works and what you are doing that needs to be eliminated or improved upon. Is all of this “busy work?” I’ll answer that question with a quote from Michael Jordan, basketball legend. “Success is something you have to put forth the effort for constantly; then maybe it’ll come when you least expect it. Most people don’t understand that.”