Have you ever widened the gap between your stop loss and your opening trade to hold a trade open longer? Have you then cancelled a stop loss order to keep your trade open? If you have, you need to think again.
Were you lucky? Maybe your trade worked for you, the price reversed and shot back – not just past your original stop loss level but past your opening price and into profit for you. That’s great. But maybe it didn’t. Certainly, it could have gone badly wrong.
The price could have continued to move against you and your closing losses could have been much worse than if you had let your stop loss order protect you. Maybe you have even suffered exactly that kind of loss.
You would not be alone. Some traders systematically sit in losing trades and try to postpone the moment of fixing losses. The two main ways they do this are:
- Having current losses, when a trade approaches their stop loss they cancel it
- Approaching the stop loss price, traders move the stop loss wider, hoping for another price direction change later
There are two main reasons for this. The first is simply failing to understand the price volatility of the asset. Some assets oscillate widely. An asset that has greater volatility requires traders to set stop loss orders suitably wide to allow for expected volatility without halting a trade too early.
The key is to recognise this and take more care calculating where to place your stop loss order. Get your strategy and calculations right at the outset and then stick to your trading plan. Don’t tinker with your stop loss order after you have set it.
The second reason traders follow these patterns of behaviour, however, is more worrying. They could be signs that you have inherent trading biases – behavioural ticks that drive your behaviour.
Often such behaviour is explained by:
- Anchoring bias
- Gambler fallacy
- Loss aversion
They can work alone, all be combined or just some mixed together in a dangerous psychological cocktail. Either way, they mean you won’t be trading logically and in a calculated, planned and strategic way.
Let’s look at those biases and how they might affect you.
Anchoring bias is an unhealthy focus on the first price. It stops you exiting a losing trade at an appropriate time because you remain focused on your entry price. Even when the evidence suggests otherwise, you believe the trade will at least move back to your start price. Unable to let go, you hang on too long.
Anchoring bias can have a couple of other impacts on your trading in different circumstances too.
You might miss out on a potential trade because you have a preconceived idea of the ‘correct’ price for that asset and it is nowhere near the current price. Your anchor price might be the last time you owned or traded that asset or the first time you researched it, for example. You don’t pay enough attention to the asset now it is not close to your anchor price.
You might also trade against the direction in which the price is moving because of your focus on that earlier price.
If you have done any of those things, you might have an anchor bias. It’s a common problem. Don’t kick yourself about it. But, now you know, take steps to counter it, focusing on real-time data and setting entry and exit prices based on technical analysis.
The gambler fallacy is the belief that some things are more likely to happen than they really are. Usually this is linked to a belief that because something has happened a lot recently it is unlikely likely to happen again. It is the belief that because a turn of events has gone one way for a while, it is bound to reverse.
That might mean that, as your trade moves against you, you have been moving or cancelling stop losses because you believe the streak of bad luck is about to reverse.
Or it might mean you move or cancel the stop loss because you because you believe that run of events must have exhausted itself and cannot continue.
Either way, you’re wrong. Look at the evidence. Even a toss of the coin, with a 50/50 chance, can land the same way for many coin tosses in a row. The roll of the dice can produce several sixes one after the other. But they are not linked. Each individual event has its own probability and is entirely independent of the previous event.
Loss aversion is a scientifically proven, in-built, psychological bias many of us have that means we place a higher value on not losing an amount that we place on winning the same amount. Basically, losing a sum of money feels twice as bad as the euphoria of winning the same amount of cash. We dislike losing more than we like winning.
Imagine a satisfaction survey that looked like this:
If winning £100 would make you tick the box ‘fairly satisfied’, losing the same amount would make you at least tick the box ‘very unsatisfied’ and quite possibly ‘extremely unsatisfied’. The same amount of money produces a much bigger emotional feeling when it is lost rather than won.
Someone prone to loss aversion will try doubly hard not to lose. You will take bigger risks to prevent a loss than you would to make a similar sized gain. Loss aversion is that feeling in the back of your mind that makes you move, or cancel, a sensibly placed stop loss order.
And it rarely works. Loss aversion leads to behaviour that actually magnifies losses.
Another impact of loss aversion is to set your stop loss too close in the first place – you often need to risk losing in order to succeed. You might even avoid making a potentially profitable trade or exit from a trade too early, once you are in profit, to avoid any risk of falling back into loss.
If you recognise any of these traits, then you are probably being swayed by your loss aversion.
How to fix the problems
Fear not. These issues are common. You are not alone. And there are tried and trusted ways to get over your biases and trade more scientifically.
- Accept losses. Losses are part and parcel of trading. We all make losses.
- Decide your attitude to risk and define a trading strategy based on acceptable risk and reward.
- Calculate your stop loss policy and work out each stop loss, allowing for the asset’s realistic volatility, and don’t deviate from that.
- Keep a record of trades, wins and losses, plus any variations you made, with reasons, so you can look back when you review your strategy or performance against it and reduce errors.
Don’t let your biases ruin your trading.