The age-old axiom of trading is that we are to “cut our losses short, and let our profits run”. I’ve realised that what we tend to do best is the exact opposite! If we don’t condition ourselves to overcome our most natural trading insincts, chances are that we tend to “cut our profits short, and let our losses run”. Indeed, latest research in behavioral finance has revealed what traders and investors of all ages have always done, i.e. the fact that we tend to take more risk with losing positions, and become very risk-averse with winning positions. This “asymmetry” or inconsistency causes us to be unwilling to take losses and also to take profits too soon. Traders are unwilling to let a trade hit a stop-loss point, because humans are conditioned to avoid immediate pain; moving (or even removing) a stop-loss order allows one to delay the pain of taking a loss, and hopefully avoid it! With regard to profit-taking, many traders fear that a profit might “evaporate” away and take it too soon.  This habit gives the immediate relief or pleasure of “locking” in profits.

If you think about it carefully, these two habits will guarantee that our profits are not sufficient to pay for our losses. Even with a high win rate, you could end up losing money!!! The right way to trade is to ensure that our profits are , on average, bigger than our losses. This is why many winning traders can be very profitable despite having a modest win rate of only slightly more than 50%. Winning traders really practise the basic principle of letting our profits run and cutting our losses short!