Using profit targets in your trading or just taking a quick profit off the table could be the worst thing for your trading. In fact… taking a profit could send you broke. This is because taking a profit limits the size of your winning trades. Keeping winners small means that your losses will more than likely overwhelm your account, sending you broke!
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I saw this quote in Richard Weissman’s book that I’m reading at the moment, Trade Like A Casino. It’s a really awesome book and I think it’s really important to share because this is one of the single most common reasons why new traders that I coach are not making money. See, the quote says that basically, when you catch a quick profit, when you try to make money by not having a losing trade, as soon as a trade gets into profit you snatch a quick profit, you close it out as a winner. The reason you lose money doing that is because you’re only ever going to get small wins and whenever your losses come along and inevitably losses always come along in trading. The size of the wins that you’re going to get by snatching quick wins with small profits is not going to offset the total amount of losing dollars of profits that you generate or losses that you generate.
So in order to make money trading, you need to allow your winning trades to grow rather than as soon as you get a profit snatching a quick profit and closing that trade out. If you snatch the quick profit and close the trade out, you guarantee that you’re going to get a small win. Trouble is when you get a loss, that loss is always going to be bigger than that small win that you’ve managed to capture. So it might feel good in the moment to capture a small win, right? Because you go, “Yes, I’m going to be right on that trade.” And if you’re feeling that way, if you’re feeling like victory because you got to be right on a trade, then you’re falling victim to this problem.
See, the problem is that as traders, as human beings who are traders our desire is that we want to be right, we want to prove our judgment right on the market. And we prove it right how? By getting a winning trade. And so if we fall victim to that human psychology, inevitably we’re going to end up losing money because there’s one thing that I’ve learned is that humans don’t make good traders. And all of the things that are psychologically easy and rewarding for us to do actually don’t make money in the markets.
So one of the hardest things to do, but one of the most essential things to do is for you to have a trade, and when it’s in profit, allow that profit to grow. And this is why trend-following is so hard for so many people because you get a small profit and you can’t take it off the table. You’ve got to let the trade continue to grow and move in your favor. And some of those trades might turn around and end up being a loss. You know, getting stopped out for a small loss. But the small number of trades that don’t get stopped out, that do continue to grow and actually shoot for the moon, they’re the ones that are going to make you all of the money.
And it’s not random chance or a fluke or anything, with trend-following the reason you make money is because you’re putting a small amount of money into lots of different trades very frequently, right? And when you’re wrong, you lose a very small amount, but you’re allowing the winners to really, really grow. And when your winners grow big, then they’re going to offset the number losing trades that you’re going to have in your account.
So catching small profits is not the way to trading success. It’s always going to lead to death by a thousand cuts because you might have a small win, small win, small win, but the next loss is going to wipe out all of those profits because they’re only small profits.
If you want to be successful, you’ve got to aim for much bigger wins and much smaller losses. And that might mean that you don’t have as many wins, right? You might have a lower percentage win rate in your trading account, but that doesn’t matter because it’s not about the percentage of trades that you get right. That doesn’t matter. It may help you feel good about your trading because you’ve got to be right more often having more winning trades, but that doesn’t put money on the table. What puts money on the table is big wins, small losses. And you only need to have 30 or 40% winning trades if your wins are big and if your losses are small and that takes the pressure off being right because being right in the markets, predicting the market, it’s actually really, really hard if not impossible.
You can design the trading system and back test it and curve fit and make it look really great like it’s got a 70% win rate and in a back test it’s going to look amazing and it’s going to have an amazing equity curve, but the trouble is in the real world when you start trading that real time on future data, you’re never going to get anywhere near 70% win rate. And all of those systems that you see advertised out there, that have really high win rate, what you’re going to end up with is consistent wins and then big losses and you end up with big draw downs.
So Tony has just commented here on this video. “True, but you need a lot of income doing it this way.” I think there’s a mistake that a lot of traders make, which is trying to support themselves with their trading account too early. If you’re trying to support yourself with a trading account when it’s only a small account, you need to be right very. And it puts a lot of pressure on your trading and when you put a lot of pressure on your trading account to win for you to make money consistently, it makes you make mistakes.
So the follow up question that Tony’s posted there is, “What happens when you do have a small equity?” Well when you do you have a small equity, your job as a trader is to grow that equity. I always advise against new traders from trying to live off their trading too soon. One of the biggest things that holds people back is pulling money out of their account too quickly. So when you first start trading, step number one is to get profitable, get consistent, and start growing your account. And actually one of the most important things is to pump money into your account once you’ve got that profitable trading system going, once you’re confident with it.
When I teach people through the Enlightened Stock Trader Certification Program, what I do is I show you how to build a trading system that suits your personality objectives and lifestyle so that you’re comfortable to do it. What that means is you can follow those rules consistently and then when you can follow the rules consistently, you can start to build your account and make money. But if you withdraw money from your account to live off too soon, it puts so much pressure on you to trade more often more quickly, be more profitable, and actually almost always ends up in disaster.
So what I like you to do instead is to get that system that suits you, get confident in it, start following it and add money to your account. Now if you need the money to live, you got to go get a job or whatever it is that you got to do at the beginning, because you can’t live on a $5,000 or 10,000 or $20,000 account. It’s just not practical. Most traders who truly trade for a living have very large accounts. We’re talking about high six figure accounts, right? And I didn’t quit the corporate world, quit my job until my account was well into six figures. And I think that’s a big mistake that a lot of people make.
So those couple of things, shooting for small wins and snatching quick profits off the table and trying to do that with a small account, that’s what really holds you back. I mean, the number one goal of a new trader needs to be get profitable, get consistent and grow your equity. Because once you start to grow your equity, then you can start to think about living off your trading. Then you can start to think about taking some of that money and really changing your lifestyle. Paying off debt, paying for holidays, doing travel, all that sort of thing. But don’t do that until you’ve got a much larger account.
So a lot of these challenges cascade or compound on each other. The trader who wants to be right more often takes small wins, has big losses, just kind of scrapes out. Maybe their account goes sideways if they’re lucky, maybe a very small amount of growth. But you’re never going to get big consistent growth on a small account if you’re taking small wins because particularly for a small account, the cost of brokerage is so high. And if you’re snatching quick trades, you’re basically giving most of your profits to the broker in terms of commissions.
So what you got to do is let your trades run further. And I would encourage you to think about taking a longer term trading system so that you can have bigger wins so you can reduce your trading costs and that’ll allow you to start to build up your equity as your account grows. Then you can start to think about trading models that allow you to extract income. But most traders have nowhere near enough equity in order to consider doing that, consider taking money out of their account.
So anyway, look, all this started because I was talking about the size of wins and size and losses. I think the most important thing is to know the expectancy of your trading system. Expectancy is the size of the average win times the percentage of winners minus the size of the average loss times the percentage of losers. If that number is positive, then you’ve got a winning system. You just need to make sure then that you risk a small amount on each trade so that over many trades you can capture the expectancy of that system. And one of the best ways of improving your expectancy in my experience after testing hundreds and hundreds of systems over the last 15 years is to go longer term.
If you’ve got a system which is just marginal, expand out the exit, allow the stock to move a little more, capture more of the profit or more of the potential move in that stock. And typically the expectancy will go up. The mind blowing thing, although the frustrating thing about that is your expectancy will go up, but your percentage of winners will go down. So that makes it psychologically just that little bit harder to follow the system. But are you after feeling good or are you after profits? If you’re after feeling good, go to the casino. Don’t waste your time in the markets because you cannot trade and feel good consistently by having high win rate systems. It doesn’t work that way. If you want to feel good and trade at the same time, it’s going to be pretty hard because psychologically humans are hard wired to feel good from things that don’t work in the markets.
Here’s the key to feeling good and profits at the same time. Have a system that fits your personality, objectives and lifestyle. Okay? Once you do that, don’t reward yourself psychologically by looking at the money, by looking at the winners. The way you feel good is to look at the end of the day and say, “Did I follow my rules today?” If I followed my rules today, then what happens? Your reward yourself because you followed the rules, you did exactly what you need to do to get to get into profit. So every day evaluating yourself, “Did I follow my rules?” What that’s going to do is give you that positive feedback, that positive reassurance you’re doing a good job. Because you don’t want to be trying to get that positive reassurance about the fact that you’re doing a good job through your winning trades.
The minute you try and do that, the minute you try and get your positive feedback from the fact that you’re getting winning trades, you’re attaching your self worth, you’re attaching your emotional wellbeing to the market and that’s a recipe for disaster. It’s going to cause you to fail, right? Much better to reward yourself for following the rules and then let the rules do their work. The rules will do their work by letting your profits run and getting big winning trade and cutting off the losing trades quickly.
So heres my thought for today. That’s all prompted by Richard Weissman’s book, Trade Like A Casino. If you haven’t read that, it’s a good book. I recommend you get it. Have a read and if you don’t have a trading system yet, then now’s the time. You know, start to think about developing your own trading system that fits your personality objectives and lifestyle because that’s the key to making trading success as easy as possible.
If it fits your personality objectives and lifestyle, it’s going to be easier for you to follow that system consistently. If it’s easy to follow that system consistently, at the end of the day you’re going to get that tick, that pat on the back, which means, “Yes I did a good job,” but the system is also profitable, which means your account is going to start growing.
So Tony’s got another question here. “What’s a good app for stocks just to watch?” Well look, just to watch, I’d suggest you get a paper trading account and start to trade, buy and sell regularly using a system but in a paper trading account. If you just want to look at the markets and see what they’re doing and participate a little bit but not with real money, then a paper trading account is a good way to do it. If you just want to watch the markets and look at charts and start to play with systems, I’m not a big fan of just passively watching and hoping it’s all going to go in. What I think is that if you get Amy broker and a data subscription so that you can update your data every day, you can start to play with some systems. You can test some ideas to find a better way to learn trading than just looking at the prices moving up and down each day.
Because if you’re looking at the prices move up and down each day, eventually you’re going to get to that point where it’s like, “Oh, I’ve got to participate, I’ve got to participate.” And then you’re going go and make a rash decision and chuck some money on the line just so that you can get that rush of playing a game. And that’s not the way to make money.
So if you’re just starting out and you haven’t yet got your system ready, get yourself Amy broker and get a data feed and start to develop some trading systems. If you don’t know how to do that, comment below and let me know that you need some help and I’ll point you in the right direction because I think developing your first trading system is the key to getting off on the right foot.
Anyway, if you haven’t already got Richard’s book, Trade Like A Casino, I think you should get that and comment below if you think you need some help to develop your first trading system, get you on the straight and narrow.
Good luck with your trading. Remember you’re only one trading system away. Bye for now.