Run your winning trades and cut your losers – This is one of those day

trading rules that’s pretty obvious, right?

So why then if it’s so obvious, should it even be a saying? Why should it be that traders find it so hard to live by and in fact, do the very opposite in

practice?

First of all, following this particular day trading rule is so hard because of the

natural tendency to be risky with losses and safe with winners.

If you choose to not take your stop, the loss is not guaranteed and

conversely, you can guarantee a winning trade by taking yourself out of

a positive trade.

Laurie Santos, a professor of psychology at Yale, illustrates this phenomenon superbly well in her

2010 Ted Talk.

http://is.gd/santostalk

When this is coupled with high levels of uncertainty and ambiguity that we

experience in the heat of the daily trading battle, you can see that it’s easy to convince ourselves that we

should bank some profit or that a big loser might just come back.

The markets are full of information and it’s not difficult to conjure signals that are supportive of our positions

(and blank out those that are contradictory) when really there are

none.

But there’s another facet to this problem – other traders may well be

looking at similar things to us and therefore acting on the same

information in a competitive manner. In particular, this can make taking a loss much harder especially if you

hesitate at all.

If the market has reached a level where if it breaches it, a cascade of

orders flow into the market, a missed exit could mean a far worse price. This

in turn feeds the first point and a trader may well hold onto a trade in the hopes that it will “come back”.

You have to change your mindset. If we look at some trading stats, you’ll

see why –

your trading stats can be annihilated by just a handful of losing trades or boosted significantly by squeezing a

few extra ticks out every trade or hitting the odd home run.

Let’s take an example of a set of 30 trades in the E-mini S&P 500 futures (ES). You have a 2 point stop and a 3

point target and your win rate is 60%.

This means that on an average set of trades, you’ll have 18 x 3 point winners

and 12 x 2 point losers. So your average per trade will be 1 point.

Let’s say that for the reasons already discussed, in 2 trades in the set of 30, you blow out. You take one loss of 6 points and one loss of 12 points – an additional 14 points of loss in total.

All other trades are taken as normal.

Your average trade now drops to just 0.53 points per trade – because of just

two trades!

And this is a fairly conservative scenario of what can happen when

traders don’t take their stops.

Let’s now say you that on 2 trades you take an additional 3 points (hardly a home run). So that’s 2 x 3 to add to

the total. Your average now jumps to 1.2 points per trade – a vastly

improved figure.

Confidence and emotional balance can be shattered when you lose more than you know you should and galvanized

by taking significant winners. Emotional strength is a depletable resource that is called upon when

things aren’t going particularly well

– so it needs to be built up and nurtured to make sure you don’t lose

control. Over time, having the emotional strength and willpower to continue with your trading plan will

help you avoid big losses and trading shocks that go with these.

The day trading rule – “run your winning trades and cut your losers” – is a very simple one. But it’s far from straight forward to live by in practice.

Understanding the absolute importance of the rule is the first step

to fully embracing it.

The next step is to ensure that your trade plan isn’t ambiguous for taking

stops and gives you some room to run winners. Then the final step is practice,

practice, practice.