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Old 01-17-2008, 07:23 PM   #1 (permalink)
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How to Stop Your Mind From Making You Take Profits Too Soon

In yesterday’s lesson we looked at how many traders use technical indicators as an additional factor they consider when deciding when to exit a trade. In today’s lesson we are going to begin to move into the next phase of our series on money management strategies, with a look at how traders go about taking profits once a position moves in their favor and some of the difficulties that are associated with this.

Before getting into the details of what a trailing stop is and how many traders incorporate this into their stock futures or forex trading strategy, it is first important to understand the trading psychology behind taking profits.

From the last several lessons you should now have a good understanding of some of the psychological difficulties people have in taking losses, and some of the different money management strategies that can be put into place to help overcome these difficulties that are the downfall of so many traders.

What may come as a surprise to many of you is that just as many traders have problems letting their profits run as they do in cutting their losses. To help illustrate this I am going to give a quote from one of my favorite books on money management strategies Trade Your Way to Financial Freedom by Dr. Van K. Tharp. When explaining this concept in his book he gives the example below:

When given a chance for “1. a sure $9000 gain or 2. a 95% chance of a $10,000 gain plus a 5% chance of no gain at all….which would you choose?”

A study which was done on this showed that 80% of the population chose the sure thing even though the second opportunity represents a $500 larger gain on average.

Similar to the way that human’s are raised in a way that does not allow them to accept losses our environment also teaches us to seize opportunities quickly, or “that a bird in the hand is worth two in the bush”, a rule that goes against the second half of the most important rule of trading:

“Cut Your Losses and Let Your Profits Run”

With this in mind we can now move into the next phase of our series of money management strategies with a look at some of the different ways that traders go about managing their position once it begins to move in their favor starting with a look at trailing stops.

Once a position has begun to move in a traders favor, many traders will implement a trailing stop which is basically a strategy for moving the stop they have implemented on their position up when they are long or down when they are short to lesson the loss or increase the amount of profit they will take should the market reverse and begin to move in the opposite direction of their position.

As you may realize from watching my previous lessons we have already gone over one precise method which many traders use for setting trailing stops, the Parabolic SAR. In tomorrow’s lesson we are going to go over several other methods, so we hope to see you in that lesson.

As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

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Old 02-06-2008, 11:38 PM   #2 (permalink)
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Missing link (with apologies to Charles Darwin)

Hey David,
The "next lesson" link skips over the "Trailing stops" lesson, and the "Trailing stops" lesson doesn't have a "next lesson" link.

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Old 02-07-2008, 11:34 AM   #3 (permalink)
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Originally Posted by rocketman7 View Post
Hey David,
The "next lesson" link skips over the "Trailing stops" lesson, and the "Trailing stops" lesson doesn't have a "next lesson" link.

Thanks Rocketman7. This has been fixed.

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Old 02-25-2013, 04:24 AM   #4 (permalink)
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I love this website

Hello David, I have been watching all of the videos in this trading course up until this video, and they have all been very helpful. I have only been paper trading about 1 week, and I plan on sticking with it for a long time before opening up a real account.

When it comes to "letting your profits ride", I was essentially taught the opposite. I've talked with several successful traders who agree that trying to ride a trend from the exact bottom to the exact top is not a good idea. They often mention "taking out the middle".

What I have been taught is similar to the system you have shown in the "Why traders hold losing positions" video (system 1). The idea that keeping a good risk/reward ratio is more important than your accuracy rating, and that the two should be partnered together instead of simply focusing on accuracy rate, like so many systems and new traders do. Of course, the person I have been learning from, raises or lowers his stops sometimes to lock in profits as well, and it's never emphasized that you absolutely need to hop out of a trade as soon as your desired risk/reward ratio is met. However, their is definitely an emphasis on risk management, and staying in a trade longer than you need to greatly adds to your risk.

I also think what kind of trader you are might effect how necessary it is to let your profits ride. The guy I am referencing is mostly a swing trader who engages in a bit of day trading. Letting your profits ride is probably a lot easier and a lot more necessary when in a longer position trade.

Although this way of trading has been working out great for me over the past week, it is in no way an indicator of how well it will work for me in the long run; I could just be having a good week. So how do you feel about "taking the middle out" and cutting your wins short once you have hit profits you are comfortable with, particularly when in a day or swing trade?

Thanks so much for these free video series; they have helped me greatly!

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Old 02-25-2013, 08:17 AM   #5 (permalink)
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hi andy,

traders who focus on the middle 60% of a trend are basically trend-riding traders. trend followers are not necessarily focused on perfect timing, but rather on getting the bulk of a trend. the idea is that they will hold the position until price starts to show weakness in some way. this usually means they will exit too early or too late, but that is fine since their strategy involves capturing the bulk of the move.

you might find our archive on pyramiding to be useful in understanding one way in which these concepts are applied.
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setting stops

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