Let Your Profits Run/Cut Your Losses
One of the old sayings in trading is to let your profits run and cut the losses. Easier said than done, right? In theory, the overall principle is a sound one: it leads to disciplined trading and the account growing. In reality, it is not that easy. Forex markets are known for the fake moves that are happening all the time. Therefore, if one is cutting the losses on a fake move, he/she will end up buying/selling the same pair once again after the move proves to be a fake one. Nevertheless, the overall principle is a solid one and we should mention it here on the Forex Trading Academy. What should also be done is to highlight the good and bad things about this principle and what the best approach to trading the Forex market is.
Money Management Principles
Money management deals with traders following a set of rules designed to protect the trading account from losses. Without a proper money management system, succeeding in trading is almost impossible. Such a system takes into account losses as well. If one is trading with the idea that losses can never occur, then the battle is lost before the start. The idea is to find a way to navigate through good and bad trades in such a way that over time the trading account is growing. The main point is/should be for the account to grow over time. In trading, like in life, there are good and bad periods, as nothing goes in one direction only. Sometimes there are things that affect traders, outside things, and this will be seen in the trading account. In theory, it is very simple: stay focused and follow the trading system. The reality is different and this has much to do with the human nature we’re bound to respect.
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Let Your Profits Run
To let your profits run means to stay for the take profit or the target initially set. This, again, it is a sound principle but in Forex is not necessarily the best one. It all depends on the trading style. One of our previous articles here on the Forex Trading Academy deals with the different trading styles and how the approach is different based on different time horizons. Let your profits run is not referring to scalpers or investors, but to swing traders. A swing trader is a trader that is having a time horizon for the trades anywhere between one day and a few weeks, as the time frames analyzed are up to the weekly charts. Even if bigger time frames are used, like the monthly chart or historical data approach, it is a top/down analysis that is involved and the swing trading principle is not affected. To let your profits run means to respect the risk/reward ratio. We know by now that such a realistic risk/reward ratio for the Forex market is 1:2 or 1:2.5. This means that for every pip risked, traders are looking for at least 2 or 2.5 to gain. This is a tricky statement, though: what do you do when the price is moving extremely close to your target but yet it is not reaching it? Are you still going to let the profits run with the cost of price reversing? There is a saying that sometimes the last pips are the most expensive ones, and this cannot be truer than in risk-reward ration. However, as unrealistic it may be, the thing to do is to follow the rules blindly. It may be that sometimes the market is turning just before reaching the take profit and the turn is so bad that it is going to hit the stop loss. This doesn’t mean anything but the analysis was wrong in the first place and the trade was due to failure.
Cut Your Losses
If letting your profits run is one thing, cutting the losses is another. This is the most difficult thing to be done in trading and there are very few people that respect this principle. This is why the percentage of winning traders is so small. Traders are not cutting losses when they should be cut! There are many reasons for this, but again, human nature dominates this chapter too. Because Forex is full of fake moves, there’s always the belief “the market” is going against you. No matter what, the market is going for your stop and by the time it is reached, the trend reverses. How many times did you see that happening? I can tell right now that this happened many times for every trader and when things go really bad the tendency is to remove the stop loss or to widen it. This is a vital mistake. It can be that the trader thinks there is enough capital in the trading account, but the main idea is that no matter the reasoning, failing to cut your losses or to stick to the original trading plan is wrong and will lead to further losses. Possibly, it will lead to losing the trading account! The purpose of this article is to pinpoint the importance of money management and why sticking to your trading plan pays off in the long run. After all, what is the purpose of having a trading plan if you’re not able to follow it?
Other educational materials
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- Bollinger Bands – Profit from One of the Best Trend Indicators
- Geopolitical Risks That Influence Markets
- Different Trading Styles
- Dynamic Support and Resistance Levels in Forex Trading
- A Guide for Trading Rising and Falling Wedges
Recommended further readings
- “Discipline and Risk Control.” Robbins, Robert. In Tactical Trend Trading, pp. 133-146. Apress, 2012.
- “Effect of market organization on competitive equilibrium.” Smith, Vernon L. The Quarterly Journal of Economics (1964): 182-201.