The goal of any trader is to make a profit. However, most newcomers make the same common mistake—they don’t set stop losses and, as a result, lose money.
In fact, if they don’t use stop losses, traders tend to stay trapped in losing positions with the hope that the market might make a turn for the better. At the same time, they often fail to hold onto profitable positions due to a fear that potential losses may cut into their gains.
What is the right strategy?
Let’s make it simple. Before starting with 3 principles for your successful trading strategy, take a look at the short formula:
Trading without stop losses and holding losing positions results in a loss of profit at point С. Hence, in order to limit your losses, you should place a stop loss for each trade.
It may seem to be challenging, as you will have to accept losses and take responsibility for their amount. But it is definitely worth it. Point C (average loss per trade) can be tamed and controlled.
Many traders strive to be right when opening positions. But markets are complex when it comes to forecasting, and making a profit at point B can be extremely difficult. There’s every chance that it could become a long and exhausting experience. In short: aim to make a profit at point A by holding winning positions.
It sounds like a complicated task: you’ll need to overcome the fear of being wrong and remain composed in the face of failure. Keep in mind that point A (average profit per trade) needs room for a rise: ‘Cut your losses short, and let your winners run on,’ they say.
‘A bird in the hand is worth two in the bush’ is a saying that often sticks in traders’ minds. In order to avoid deep disappointment in the face of lost opportunities, protect your profit.
Move the stop loss level with the growth of a profitable position.
And that's it! This short checklist will help you to ask yourself the right questions at the right time.
It is worth mentioning that professional traders strengthen the implementation of the second principle by applying a pyramiding strategy. They scale in and add to winning positions while moving the stop loss level so that the potential loss remains the same.
Did you know? Such irrational behavior—closing winning positions quickly and holding losing positions for a long time—is called a ‘disposition bias’, and the term is widely used in behavioral finance.