One of the most iconic images people have of Wall Street is the scene from the first Wall Street film where Gordon Gecko delivers his infamous monologue that begins like this, “Greed, for the lack of a better word, is Good”. Since greed and it’s first cousin fear still drive markets, it does serve a purpose in terms of creating opportunities for those who understand its nature. When it comes to short term speculation on the other hand, it can be very counterproductive to your performance.
How many of you can relate to the following situation? You enter a trade based on your plan. Everything has lined up. It is an intraday momentum trade. Your stop is 10 pips and your target happens to be 20. You are in the trade for 20 minutes so far, you see signs of hesitation, but you are up 18 pips. The market is 2 pips away from your target. What do you do? Close the position? Or wait for your target?
When you read this situation and think about it with nothing at stake, no emotional involvement, the answer is easy: take the 18 pips and be happy. On the other hand when you are in the situation with money at stake, something else interferes with this simple logic. Suddenly you say, “This can go two more pips so I’m holding it.” What do you think happens next? You go from up 18 pips to up 8 pips. Now you say, “Okay, I just have to be patient with this, this is just noise. Once it goes back up I will get out.” Then what? It goes negative and stops you out.
Why does this happen? What makes you stay in that trade? This is a prime example of our greed impulse at work combined with some fear of missing out or conspiracy theories about how the market maker never lets you out at your prices. Whether you should take the money or not actually has more to do with the type of trade you are in and what the expected potential is.
If you are in a scalp, which means the trade probably has small potential, you are better off taking your profits at the first sign hesitation. If you are in a momentum trade and you have gauged your potential at 30 pips, then you should probably put your stop at break even and hope for the best. Experience will be your best guide as you move forward in your learning curve, and from my experience there is no simple solution to this problem.
If you are trading multiple lots, you have more options. For example, if you are in that same momentum trade where you are expecting at least 30 pips, take half of your position off at 1:1 reward to risk and set your stop to break even for the remainder of the position. This allows you to lock in some profit, reduce risk to 0 and open the possibility of reaching your potential target.
Now if you do not address this scenario within your trading plan, you will not have any procedures for making adjustments when the market requires it and this is what leads to more impulsive behavior. You will remember the one time you got out for your 10 pip profit only to watch it run 25. This kind of market randomness has the potential to drive you out of your mind.
When your trading plan or structure is not well defined, you increase the chances of letting emotions like greed lead you to ineffective behavior like letting a winner get stopped out. As you go forward in your learning curve, make sure to have a procedure in place however simple to act as an objective guide. As humans we can’t eliminate emotion from our discretionary trading efforts, but we can come up with a set of guidelines to help us effectively navigate the randomness of the market.
—
Marc Principato, CMT
*No Relevant Positions