Do you ever get these feelings when a trade starts showing a nice profit…
…deep down you know you should be letting the trade run-on, but the urge to cash-in becomes almost unbearable?
Today, I’m going to show you two little tricks my mentors taught that helped me overcome this exact problem.
They’ll be useful for you to know because cutting profits short is one of those paradoxes we must often overcome as traders.
What would otherwise be classed as an act of self preservation in the ‘outside world’ can have the exact opposite effect in the markets.
After all, I’ve very often heard traders say things like “you can’t go broke by taking a profit”. But I disagree…
I think the key factor is how much money you might be leaving on the table by bailing out too early. Leave too much behind on a regular basis and you can seriously impact your potential results.
And the only way to really overcome ‘the urge’ is by over-riding the natural emotions you go through when your trade first shows good profits.
But do remember, it’s just your ape-brain trying to take control. It does have your best interests in mind even if it’s a little misguided. It’s sending you an urgent message…
“You’ve found something good, take it, take it, before you lose it!”
These instincts served your caveman ancestors very well. Every bit of food they had the good fortune to stumble across and stash away could be the difference between life and death.
Problem is, evolution has been slow to change the way our brains are wired. And to really maximise success in the markets we need to adopt a more controlled exposure to risk.
So here are those two techniques I mentioned earlier:
I must give fair warning though – they are not for the faint of heart…
They both stretch the trader’s comfort zone as a pathway to allowing trades to fully develop. But if you do try them out, please make sure you don’t go risking anything over and above your own personal pre-defined trading limits.
So the first thing my mentor had me do was take a one-contract position in the market – and never be flat.
I could change direction as a saw fit… for example, I could be long all morning and then flip to a short position if I thought I detected a change in trend, but I could never be completely out of the position.
The exercise lasted for two weeks. I was learning to trade T-Bond futures which moved at $32.50 per tick but for this exercise he had me take a position in the Mini Dow futures which ticked at $5.00 (less risk but still with real money on the line).
And this was all about getting over the tendency to focus on trading for profit.
Sounds a bit backwards doesn’t it?
But if you focus on getting yourself in tune with the ups and downs of price, the profit will inevitably follow.
Again, it’s one of those trading paradoxes – if you want to make money from trading, forget about making money!
Get yourself to do the right thing at the right time and the money will look after itself.
And I’ll tell you what, watching the price action develop when every little flicker on the screen makes or loses you $5.00 – especially when you know you can’t avoid it – has a way of gripping your attention like nothing else.
You start to notice little quirks and characteristics of the market because you are financially committed and fully involved. These are things you probably wouldn’t pick up on if you were casually observing your charts with no stake invested.
(If you did want to conduct a similar exercise yourself, the micro lot Forex contracts can let you have a go for pennies per pip.)
So once we’d been through the mill with the first exercise we were relieved of the requirement to always be in the market. We could now actually choose when to enter our positions!
This second exercise helps you overcome the tendency to cut your profits short:
This time, you could choose when to get in, but when you felt the urge to exit the trade, you had to double up. You bought a second contract instead, adding to your position.
And you know what, very often the trade rolled on into super-size profits. Put yourself through that initial pain-barrier of going against your instincts and you’d often see four or five times the return you’d have gotten if you took the first ‘scared-money’ exit.
Now this technique of adding to a winning position can be developed into an essential part of your trading toolkit.
It was Jesse Livermore’s secret weapon. He was the incredible trader characterised in Reminiscences of a Stock Operator. Also known as ‘The Boy Plunger’ for the huge positions he ran from a young age (he started trading aged 14).
Livermore called this scaling-in technique ‘pyramiding’…
Imagine an upside-down pyramid – in fact, here’s a diagram:
What Livermore did was to identify a potential turning point in the market and make his first entry (a small test trade) when the market explored that price area.
Next, if the market showed the intention to carry on moving as anticipated, he might double-up his position. In the example above, the market moved upwards proving the analysis to be correct. More contracts are added at the 2nd entry.
The market carries on upwards, more contracts added at the 3rd entry…
Until eventually the new direction of trend cannot be disputed and the full position is loaded-up.
Don’t forget, there are already paper profits showing on the trade which provides a nice safety cushion. You might even be able to get a stop loss order working at break-even level for the whole position.
The beauty of this technique is that you are almost never heavily positioned when a loss is incurred. You can happily let the market prove you wrong at the 1st entry stage multiple times because you know it’s only a matter of time before you are rewarded with a trade that snowballs into massive profit.
I don’t know about you, but it makes so much sense to me to scale into a position like this… you can take things cautiously, letting the market prove your judgment correct with hard cash.
And the profits you start racking up can then fund the purchase of your later additions to the trade – it can become a self-perpetuating wealth building machine… growing exponentially at each stage.
Jesse Livermore certainly found it to be so (his only problem was actually keeping his hands on the vast sums of money he made!).
So would you agree that’s a smart way to manage your big-money trades?
If you do, how would you like to scale-in to a successful trading strategy using those same smart-money principles?
If there was a way you could make a small ‘test investment’, receive the strategy in full, and then let it prove your judgment correct by the amount of profit it awards you, would you be willing to take this zero-risk trial?
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Be Prepared: Market Moving Data Coming This Week (London Time – BST)
Wednesday 19th February:
09:30 GBP Claimant Count Change
09:30 GBP MPC Meeting minutes
19:00 USD FOMC meeting minutes
Thursday 20th February:
08:30 EUR German Manufacturing PMI
13:30 USD Core CPI
Friday 21st February:
09:30 GBP Retail Sales
15:00 USD Existing Home Sales
I hope you enjoyed this week’s issue… have a think about how you could manage your big-money trades using Livermore’s scaling-in strategy.