The Psychology behind the Old Adage

As traders we have all heard the old saying "cut your losses and run your profits" countless times. It is one of those pieces of advice that is both simple and logical, and yet frustratingly hard to implement for the majority of those actually trading.

Today, we want to look at this problem from a psychological perspective. We know by its very nature that the market moves up and down - or to be more mathematical, reverts to the mean - much of the time. As a result of this, when new traders find themselves on the wrong side of the market and losing, they hope at some point that it will come back. The flipside of this, of course, is that if they are on the right side and winning, they worry that it may turn and that they may give some, or worse, all of their profits back. The reason it is so hard to overcome this mindset is because it has been programmed into us. As one trading psychologist wrote, this problem is due to the fact that we are "taught" from an early age that:

a) If we lose something it will eventually come back (e.g. If you lose your car keys, do not worry, they will eventually turn up)
b) If you see something, take it or you might lose the chance (e.g. If you see money lying in the street, pick it up quickly because it may not be there for long)

And so these attitudes translate into our trading. However, to be a good trader requires going against what we have had ingrained in us. It often requires going against what both our heads and our hearts tell us. The real reason trading is so hard is that we need to reverse how we think: when trades are going against us we should be fearful not hopeful; when trades are moving in our favour we should be hopeful rather than fearful.

So how do we manage to do this?

One of the ways to remain disciplined in taking your losses is simply to pick a point before you place a trade that, if the market hits it, proves you are wrong in your analysis. Once this is chosen, you should never, ever, move your stop further away. Many novice traders choose a stop and then as the market moves towards it they manage to convince themselves that the market will turn after their stop is hit and therefore justify moving it further away. It is important to remember that the market has a way of frustrating every trader, but the greatest traders are flexible. If you are wrong in the short term, close your position and wait on the sidelines where you can see clearly until the market moves in the direction you thought it would. Timing is everything when you are trying to make a living do this. If your timing is wrong, then you need to take action and prevent losses. Sometimes the market may give you another chance but you can bet the time you need it to most, is the time you will not be given it!

So, that's how you should cut losses. How about letting profits run?

If you are in a situation where the position you have taken is significantly in profit, take a minute to sit quietly and think rationally. You need to focus on the fundamental thing that your position is now telling you i.e. you have called the market correctly. A key thing to remember in winning trades is that being up should not be a justification for getting out. This means that you should not look at your P&L and then begin to look for reasons to exit your trade. It all comes back to having a trading plan. A trader that wants to succeed needs to constantly remind themselves why they took the trade in the first place, where they originally thought the market was going to go and as a result, whether the reasons for still being in it are valid.

Successful traders are able to accept they are wrong and make the situation right by getting out but at the same time they are able to see when they are right and can fully maximise their opportunities by holding on with the strength of their convictions.

Translating Fundamental Information

The central role played by US monetary policy, including Q.E., and the $ in global financial market correlations; the implications of Jean Claude Trichet omitting the phrase “strong vigilance” from yesterday’s E.C.B. introductory statement; the significance of a potential uptick in the US unemployment rate in today’s Employment Situation report. All of these are key fundamental issues that professional Proprietary Traders must understand and whose evolution they must be able to track and interpret in the blink of an eye. However, the most capable fundamental analysts do not necessarily make the most capable traders.
Much time is dedicated during our 12 week training programme to developing trainees’ ability to understand the fundamental backdrop to the global financial markets. Also, beyond the 12 week process, traders enjoy the benefit of both weekly strategy sessions to plan for the key events of the coming week, as well as ongoing informal discussions with senior traders on the trading floor. However, the vital question often overlooked by novice traders is “how do I translate this fundamental information into my trading?”
There are no prizes in an environment such as Futex for being able to out-analyze either your peers or any other market participants. Rather, it is the ability to effectively translate such understanding into your trading, and thus your end of day/week/month P&L, that really counts. It takes both time and deliberate practice to develop the skills required to interpret fundamental information, and yet more time to be able to effectively translate this understanding into trade ideas. However, the process is much quicker if individuals are acutely aware of the need to make this end-to-end link from the outset. For example, from day 1 of the 12 week training programme, trainees are involved on a daily basis in up to 2 hours of reviewing market fundamentals. At every step, a direct link is made between what is read in either the Financial Times or in an analyst’s report and trading. The clear rule of thumb is – unless you can take a fundamental piece of information and translate it into a specific trade idea or it directly supports/enhances your trading decisions, it is superfluous.
Proprietary Traders have to interpret a huge amount of information on a daily basis. A key skill is being able to sift through this abundant information and hone in on that which is most important. As a novice trader, it is all too easy to get bogged down in excess information at the expense of effective trading and paralysis by analysis is a common outcome if this is left unchecked. Making consistent profits is the outcome goal for all of our traders and nothing should distract them from the relentless pursuit of this.

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