Cut Your Losses:
This section goes hand in hand with another section entitled “Let Your Winners Run”. Keeping your losses in check is one of the most important aspects of being a winning trader. If you don’t limit your losses, you create big problems for yourself in a number of different ways.
Here are a few of the ways:
1. First you will end up taking some very big losses which will be tough on you psychologically.
When you take a loss that is a lot bigger than your daily win, you have to win a number of days in a row just to make up that loss. It isn’t easy to win every day, so it will likely take you several days just to get back to where you were before the loss.
2. One large loss can wipe out many days of small or moderate wins. If that happens you are likely to feel like you worked a long time for nothing and it is bad for your morale.
If you do allow losses to get out of hand, many times you will end up getting a large portion of the loss back the same day and end up closing out the trade with a small loss or perhaps even a win. This is actually not a good thing for you. When this happens, it reinforces the idea that your behavior is okay and teaches you bad habits that will eventually catch up with you. Sooner rather than later, you will get crushed on a few trades that you should have cut short.
Let’s look at what happens when you do cut your losses short. First off, you take very few, if any, large losses. That means that any big wins make up for several losing trades. It also means you can be confident when you enter a trade that your risk is reasonable. If you are always comfortable with your risk, you generally think more clearly and are more likely to make the best decisions.
Sometimes it is hard to realize that you can always get back in later. If a trade is going against you and you believe it will eventually reach your target, it is usually better to cut the loss short and re-enter when the downtrend falters and show signs of turning around. Or better yet, you can just exit the trade for a small loss and look for a new trade.