I jumped at the opportunity to participate in the upcoming Festival of Learning hosted by RealVision. (Here is where you can sign up for the sessions that run from September 2nd - 4th). My eagerness came from the chance to speak with Mark Ritchie, Jr., an experienced trader and fund manager. I wanted to hear his take on trading psychology and the challenges he faces running his own fund.
So what was one of the very first things that Mark discussed in our pre-recorded session? Was it managing his losses or staying in emotional control of his trading? No. It was letting his profits run. He wisely pointed out that a trader can be great at limiting losses and getting stopped out, but still not make the most of his or her trades.
Mark questioned the wisdom of the old saying that you can't go broke taking a profit. Because much of a trader's total return comes from a handful of top opportunities, taking profits prematurely can cap success. This is why, in my work with traders at SMB, we focus on monthly statistics and pay particular attention to whether the average size of winning trades is greater than the average size of losers. Many times that ratio needs improvement, not because the trader is letting losing positions go or adding to them, but because they stop out of winners before the positions have hit their targets.
Here's a big psychological point:
The traits and strengths that we need to limit our losses are different from the ones we need to maximize our gains. We need to consider these as separate skill sets and work on them independently.
Limiting our losses is all about prudence and conscientiousness: the ability to be careful.
Maximizing our gains is all about willpower: the ability to sustain a goal in the face of uncertainty.
Mark's insight was that, for experienced traders, the prudence comes naturally. If it didn't, they would never get to the point of being experienced! But tolerating uncertainty is different. When we watch our positions tick by tick, it's easy to see something concerning and use it as an excuse to bail.
There's an old saying: failure to plan is tantamount to planning to fail. If tangible targets for our positions aren't firmly set in our minds and mentally rehearsed, we will have no goals to focus on to get us through the uncertainty of price paths. The real problem is not just getting out of trades too early. The problem is failing to set vivid goals for our trades that energize us and feed our willpower. Come to think of it, that's a problem many of us face in life as well as markets!
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