When to fold: tips for cutting your trading losses
The scientists at the University of California, Berkeley, and the University of Oxford found that anxiety makes it harder to make decisions and avoid bad outcomes. “It’s a bit like being Alice in Wonderland, trying to work out what choices you should make,” the paper says. So, when a trade becomes bad, your ambition might be telling you that it’s “Black Thursday,” and it’s time to panic sell like it’s 1929. But hold your exit button.
There are profound biases in how traders view gains and losses. Even world-class traders fall into the trap and mismanage their billion-dollar positions. To avoid falling into a distressed mindset when the asset goes into the red, have a plan detailing when and how to cut your losses. At the end of the article, you’ll also get an expert tip for growing your confidence with your good trades.
1. Exit when you can’t read the market
Sometimes, you set up a trade, and the market starts moving in the opposite direction. If you don’t know why, and you’ve lost track of what is going on, consider it a strong suggestion to leave the trade. Whenever you catch yourself making random guesses about what might happen next, it’s time to take a pause. Only in this case, you can’t step away without handling your losing position first. Make an exit and revisit what happened at a later time.
Suppose the unexpected market move has an opposite effect on you — you have the explanation, your funds can sustain it, and you are certain the move will be short-lived. In this case, leave your position open until the downturn reverses. Perhaps the big gain you were originally hoping for is just around the corner.
The best articles in your mailbox
Subscribe and get essential info on trading weekly
Great! Please check your email
We've sent you an email to confirm your subscription
Something went wrong
Try reloading the page. If that doesn't help, please try again later
2. Exit if you feel too emotional
Traders have different reactions when they are faced with a loss. You may feel betrayed by the market and go into revenge mode. You may be confused and refuse to do anything, hoping the situation will better itself. You may set unrealistic expectations thinking you can rectify any damage. Any of these reactions prevent you from making a true assessment of what is happening with the losing trade.
You don’t need to exit the moment you get emotional. But if the feelings of panic, anxiety, or pride begin to get the better of you, that’s when you should seriously consider making an exit. Although, try breathing exercises, check your strategy, and use critical self-reflection to save the moment first.
3. Exit if your technical analysis says so
So far, this article covered extensively what it means to lose objective insight. But it’s important to also talk about gaining a fresh perspective when the times are bad. Technical analysis should provide you with an answer.
Just like you used technical analysis to determine the time to enter the trade, use it to interpret the current circumstances. Technical analysis might not tell you why the market is going against you, but it can be a valuable tool in forecasting the market’s next move. Look at the chart, draw support and resistance levels, and pick up signals from oscillators and moving averages. Do they all suggest that the market is adjusting and will soon get back on track? If so, keep the position open.
Or, did you get several confirmations of an entirely new pattern forming and putting your trades in the negatives? Then it’s not a temporary trading loss, so you should close the position.
4. Exit if you hesitate
Suppose you’ve made all the recommended evaluations from above. You can read the market, you’re not too emotional, and your trading indicators signal the consolidation phase will end soon. But despite all this, you still feel uncertain about this trade. Don’t stress out more than you need to; close the position and move on! It’s a good habit to have anyway — if you’re conflicted, stop before you make things worse.
That’s not to say that hesitations about a trade mean it will continue losing. But it’s a good exercise in using your trader’s instinct. If you intend to keep a systematic approach to active trading, you will still need to work and hard and improve your strategies. The trader’s instinct will just become the final touch that brings everything together: charts, data, signals, feelings, and decisions.
How to become better at cutting trading losses
It’s good to get advice from accomplished traders. Learning gives you a great foundation to work on, but time and experience are the fundamental ingredients for a successful path. Nothing teaches you quite as effectively as practicing the same thing over and over again. As you become more experienced, the difference between a terrible trade and a temporary setback will get clearer.
Take a note of situations when your decision to cut losses was correct and compare them to situations when you acted prematurely. Eventually, your decisions will be as informed by the sixth sense of a veteran trader as they are by the data. But don’t rush it and ignore the data just yet!