Tuesday, 22 June 2010

When To Green

It is often written that you can’t go wrong by taking a profit, a topic raised again recently by Against All The Odds. While that may seem to be a quite reasonable statement, it actually is very misleading.

In trading, one of the hardest things to overcome is the urge to take a profit at any price. Traders have a natural tendency to cut their winning trades short, and let their losing trades run, when the optimal strategy is to do the precise opposite.

No one takes a position expecting the market to move against them, but this possibility is inherent to the nature of investing. The goal is not to avoid losses, but that losses are kept to a minimum.

In reality however, investors don’t like to admit that they made a mistake, and let the bad trades go even worse.

On the other side of the coin, if the market moves favourably after taking a position, the novice trader gets all excited at a profit, and trades out.

There are good and bad wins, just as there are good and bad losses, and it’s just as important to keep a clear head when things are going well as it is when things are not going so well.

The position should only be exited if it is value to do so. If you back at 2.0, and the price drops to 1.5, only trade out if the perceived probability is less than 0.67. If the probability is greater than this, it usually makes no sense to close the position.

There are a couple of exceptions to this though.

It might make sense to reduce your position if you are using Kelly staking, as your position might now be a higher percentage of bank size than should be the case.

Also, I can accept that in an extreme example such as the one I included here, a windfall amount makes it perfectly understandable to trade out at a less than value price.

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