This is why setting stop losses is vital to successful trading. We need to clearly identify what would tell us our trade is wrong and commit to exiting immediately. For example, I may see selling pressure in the stock market, with several minutes of negative NYSE TICK readings. I notice that the market cannot move below the previous level at which we had similar selling. On the first sign of buying pressure, I go long and my stop is at the most recent lows. Right away, this provides a favorable risk/reward. It also makes good sense to me because a violation of the recent lows tells me that buyers have not taken control.
Such setting of stops is as much a psychological exercise as a risk management one. It is not enough simply to identify a price level for exit. This must be an emotional commitment. By mentally rehearsing scenarios in which we're stopped out--visualizing the market action that would take us out of a trade and how we want to respond--the setting of the stop becomes an emotional preparation to handle the loss. If we are mentally rehearsing a negative scenario and making that scenario familiar--and if we know in advance how much we can lose on the trade and can accept that--then losing no longer becomes a shock or a threat. Repetition takes the emotion out of negative scenarios.
We always want to create psychological safety in our trading. Our sizing and our stop losses should be such that we can lose and always come back. As I've mentioned in the past, we should never lose so much in one trade that we cannot be profitable by the end of the day. We should never lose so much in one day that we cannot be profitable at week's end. And we should never lose so much in a week that we can't have a winning month. If we achieve that kind of consistency of process, we will be consistently profitable and cultivate a consistent trading psychology.
Further Reading:
Using Emotion to Change Emotion
.
Posts
