What happens when you have placed your trade and you immediately have second thoughts as you watch the market moving against you?
It is a normal trading experience to have a position that has moved in your favor a certain distance but has begin to stall before it reached the price that you were expecting it to reach, or which you have established as a reasonable price target.
As soon as you see the price start to reverse and move against you, you are presented with the age old problem of whether or not you should cash the partial win or remain disciplined, and true to your trading plan and let the price go where it will.
Psychological studies have repeatedly found that we are affected emotionally about three times harder but our losses than our gains. So, to see a profitable position move against you into the red is especially painful because you have experienced the loss of profits (which you will measure from the highest high of the trade) compounded by the triple pain of a loss.
Unfortunately all traders who have experienced this decision have also seen what it feels like when they have taken the partial profit and then witnessed the position reverse once more and zoom upwards to new highs immediately after exiting their position. The emotional response to missed profits hurts just as much as actual dollars lost according to psychologists.
Because of the way our brains are wired the instances where we chose incorrectly stand out more in our memories than all the times we made the “right” decision.
After this has happened to you a number of times, you start to second guess yourself, and you can get gun shy about any decision you make, to the point where you cannot rationally approach the subject. It is common for traders in this psychological state to look for a perfect exit rule that allows them to be “right”, to give them an insight into the “correct decision”.
The truth is that no one has the perfect solution to this dilemma; no one can be “right” all the time.
The good news is that you don’t have to be “right” to have an effective exit strategy.
What you need are psychologically acceptable rules for exiting and for re-entering positions. This means they must be acceptable to you!
By having a good re-entry plan you no longer have to worry about missing the great move that kept you in a position that was moving against you. This gives you the confidence of capturing the profit in hand before it disappears and becomes a tangible loss.
By being effective in preserving capital and profits, and by being able to re-join a winning position you can stop worrying about being “right” all the time, and simply concentrate on making money.