Top 5 Reasons You TAKE PROFIT Early | Trading Psychology

Hello and welcome to lesson four of the Advanced Psychology course, the High Performance Trading. This video is on letting your winners run or perhaps as most traders experience the Problem Taking profit Early if we strip trading back to basics, there are three core let winners run and cut losses so that overall you make more money than you lose and protect your account with sound money management in some form or other. All profitable traders respect those principles. But I'll start by saying that what is mathematically optimal is psychologically difficult. Knowing what you should do, no matter how simple it is, doesn't mean you can do it. And the funny thing is, you may be making the mistake of not letting your winners run without even realizing it. You may have incorporated this mistake into your system rules, thinking that you're doing the right thing. I'll explain that in a moment. The most obvious problem we've all experienced is the urge to take profit even when our rules say otherwise. So assume that you're in a buy position, but immediately after your entry the price reversed and it spent a considerable time underwater close to your stop. And you're almost certain this is going to be a loss. If it eventually comes back to your entry level, then there will be a sense of relief. You're just grateful that you've got away with this. So you take profit and you thank your lucky stars. That's one scenario. But of course the urge to take profit early can come from any number of reasons. Your last few trades may have been losses and you just want to end the losing streak and experience a win for a change. You may have been on a winning streak and you don't want to spoil that with a loss. One more win may give you the longest back to back winning streak you've ever had. So who cares about the size? And a win is a win and it adds to your record. It may be that you've heard some news or rumors and you're fearful so you want to take profit before anything bad happens. Or the classic case where your memory is recalling all of the times your winners turn around and become losers so you take profit quickly before that happens to you yet again. There are just so many things that can trigger that urge and I'm sure you can relate to them. But you may be taking profit without even realizing it. You may have coded it into your system believing it's a good thing. I'm talking about scaling out of winners or taking partial profits. This is often given as supposedly good trade in advice, but it is a mathematical mistake. It's a classic case of your system 1 hijacking system 2 to fool you into thinking that there is a logical reason for your behavior, when really it's an emotional reason. So let's say you buy two units and you have a 100 point stop loss. If your trade loses, you lose 200. But when it goes into profit, you take off one unit at, let's say 50 points and you leave the remaining unit to run on when the price reaches 100 points. So a one to one ratio to your stock loss between the two units, you have a maximum profit of only 150 compared to the loss of 200. Have the price gone against you? Now people will defend this strategy with their last breath. But any way you measure this, it is failing to let your winners run. It is taking profit early. You've made sure you have your biggest position size open when you lose and the smallest position size when you win. It is not mathematically optimal. It is a purely psychological crutch. We now know that a large part of overcoming these seemingly simple trading issues is about improving your awareness of what's being pushed up from system one to the unaware. It feels like a soup of feelings, impulses and thoughts that all feel right, as if it should be acted on immediately. But the more you can untangle this mess and develop better self awareness of exactly what system one is is trying to achieve, the more likely you're able to choose whether or not to act upon it. Because remember, these pushes are not all bad, they just need evaluating. So for this lesson, we are specifically concerned with any urge to close winning trades and take profit early. And I'm going to focus on five main contributing factors. At different times you may have experienced one or all of these. Let's start with the first and the simplest one, Winning. It goes like saying that humans are fundamentally motivated to try and win. We are a highly competitive, strategic and at times aggressive species, which has served as well in terms of our survival. Historically, the battles that we have fought, either individually or collectively, have been simply won or lost. The winners survive and the losers either lose their life or are at least very much less likely to reproduce. And while the modern world may be much safer, we continue to carry that deep simplistic drive to win. The reason sports have taken such a hold in every single culture across the world is that it allows us to exercise and vent this deep drive to win. But a binary outcome like that is not suited to trade in. Let me explain. In basketball, for instance, if the Chicago Bulls score 48 and the New York Knicks score 46, the Knicks are still losers, regardless of how clubs it might have been. It doesn't matter if the lead was two points or 42 points, and that's the problem. Winning and losing is a form of binary analysis which is fining sports, but it can have dire consequences in trading. Seeing individual trades as a win or loss battle can trigger one of the worst parts of our defensive systems. And closing the trade even just one pip above your break even point will be seen as a success. So that's the first problem to try and bring to your conscious awareness and try to examine do you feel the need to win Individual traits Experienced traders are less concerned about whether the individual trade is a win or loss, which can seem counterintuitive to newer traders. Inexperienced traders may accept that losses happen, but this is usually only at an intellectual level. At an emotional level. In the heat of the moment, they easily get hung up on the need to win. But trading is a probabilistic activity. The outcome of individual trades in isolation are irrelevant, something that I will cover in a lot more detail in later lessons. Now this win or loss framework that put around individual trades is often triggered by trading in the wrong mental and physical state. Being stressed, anxious or physically overstimulated on any level will have a profound effect on how you perceive individual trades. Stresses from previous trade outcomes, work, health and family worries can all end up affecting how we trade. Symptoms like elevated heart rate, physical tension, sweating and nervous habits such as twitching or tapping are all signs that we may be about to trade from our most basic human instincts. Seeing it as a battle to be won at any cost and seeing it as a battle is misinterpreting the threat. It activates your self protection sub self which if you remember from the previous video, is the first and the most powerful sub self within System 1. It assumes because of our history and how System 1 evolved that you are facing a physical threat. So your fight, flight or freeze response is being primed. You are getting ready to respond physically and the trade is treated as a battle that must be won. Remember, from a survival standpoint it makes sense that the sub self is oversensitive and overreactive. There is no penalty for assuming the worst and overreacting and being wrong. But if it underestimated the threat and got it wrong, the penalty may be fatal. And to get you ready to respond, it floods your body with powerful hormones. So in a way you are now trading while intoxicated. Elevated heart rate, faster breathing and a feeling of excitement at the prospect of taking profit are all the result of chemical reactions that act as narcotics in the body. And that narcotic is boosting your confidence, sharpening your attention, and preparing the expectation of a dopamine hit. When you close that trade and you conclude that you've won that battle, it's not until afterwards, when the narcotics have worn off, that you realize you've overruled your trading strategy and you got carried away on internally secreted drugs. Now, as your intuition and experience grows, this chemical release will become very useful in communicating high threat market situations. But for most beginners and intermediate traders, this reaction misfires and it can frame individual trades as battles to be won or lost. And this results in a decision mechanism that will try to win as soon as possible at any cost. If you've reduced the meaning of an individual trade to a win or lose battle, your mind will be looking for any opportunity to win as soon as possible, pretty much as soon as the trade is in profit. And just remember, you're unlikely to experience this in a dental or a micro account. But as soon as the account size increases and significant amounts are at risk, the stronger this urge is going to be. You may be more familiar with this mechanism at play at auctions. You may have gone to an auction with an upper limit or a plan in your mind, but the competitive atmosphere can trigger you into a win lose battle where you're up against an enemy, another buyer, and it becomes a battle that you need to win. When the auction's over and the battle is won and that sub self retreats to a more dormant state, you can easily be left with an object that you've paid well over the odds for and you're questioning what on earth just happened. This is one of the most powerful types of decision hijacking there is. And once it's in control of your trading, it will spot any premature opportunity to win. It doesn't understand profit targets or trading plans, nor does it care for your long term goals. It's only interested in protecting you here and now, and you can't turn it off regardless of the fact that you're not actually under any physical threat or whilst you're trading. It is on 24 hours, so you need to be aware of it and learn to recognize the early warning signs, physical and mental, that it's about to take control and then develop and strengthen your oversight to be able to prevent it. And hopefully this course is going to help you with that as we progress. Very briefly, looking at trading, think about what might affect you personal circumstances like relationship problems or financial hardships. Those things can already feel like a battle and you can easily carry that over into your trading as a natural continuation of your existing mood or demeanor. Pay attention to physical sensations and behaviors. Increased heart rate, trembling or restlessness, agitation, feeling anxious, maybe feeling angry at whatever the price is doing, or competitively willing the price to go in your direction and punching year in triumph. Once it does go where you want it to, you really need to be very self aware of these behaviors and actions that you have. This is why pre trade routine is so critical to get you prepared correctly or for identifying when you're not in the right frame of mind. I'll explain pre trade lutines in more detail later in the course in another lesson. Now let's move on to the next driver of not letting your winners run the need to be Right It's a very similar to the need to win in that it's still a battle with a binary outcome. But this is on a more conceptual level. It feels much less physical, so it has far less obvious symptoms. In its simplest form, it's the need for our prediction or opinion to be proved right. We've all been there. When we get into a debate with someone, regardless of the evidence that we are wrong, we stick to our guns and we don't want to back down, we don't want to be proved wrong, or more importantly, we don't want to be seen to be wrong. That is our ego trying to ensure that other people's perception of us is maintained. It should be obvious that in a probabilistic environment like trading, this need to be right is particularly maladaptive. We've signed up for a career in in being wrong an awful lot of the time. Well, that's if you see losing trades as being wrong, which professional traders don't by the way. But if you do see a loss as meaning you were wrong, in a winning trade so far at least you're right, but it could reverse and prove you wrong. So cutting the trade early and taking profits secures your sense that you were right. You will throw away greater profits simply due to the need to be right and the fear of being wrong. Experienced traders know that whilst their decision to enter a trade may be based on something statistically valid, it doesn't guarantee a particular outcome. At best, they may have a slightly increased probability of a particular outcome. So good traders detach the result from the entry. But even professional traders can sometimes lose this perspective, especially if they have a very high conviction or or belief that their entry has or will predict the price direction. This is especially true if they committed a lot of time and energy to analysis and have convinced themselves of a developing move. But any form of conviction is anti probabilistic. High probability does not mean you should feel convinced that the trade is going to do anything in particular. And if you see trades going the other way to your trade prediction, then being wrong can dent your ego. The need to be right is pervasive amongst humans. We often take being proved wrong as a slight against our character or our intelligence. When we're not in control of this urge, we're just a slave to our deep drives to be seen to be right. But where does this ego come from and what is it trying to do? It seems irrational, but as we're living there are highly rational reasons as to why you want to be proved right and and be seen to be right. It's the status sub self. If you think back to the sub selves covered in the previous few lessons, you'll remember the sub self that is purely concerned with gain in status. From a survival point of view, being proved right is outward evidence of your intelligence and situational awareness which impacts how you see yourself and importantly how others perceive you. There are major advantages to seeing yourself as someone who makes good decisions and and obviously huge negative implications for people who display self doubt or are seen by others as being poor thinkers. But gaining status whilst being extremely useful from a survival point of view can create huge obstacles in intellectual activities like trading. Wanting to succeed at trading in order to prove to oneself or to others that you are a capable individual is is unlikely to result in consistent trading behaviors. All trading strategies, regardless of their methodology, be it technical or fundamental, only suggest what is likely to happen, not what is certain to happen. Every trade has a probability, not a certainty, and therefore the outcome of an individual trade has nothing to do with whether you are right or wrong. If you do go into a trade framing the outcome as being right or wrong, you are destroying your probabilistic thinking from the outset. I spend two whole lessons in this course video 7 and 8 talking about probabilities, so you'll understand this more when we get to those lessons. With regard to taking profit early, if you view the trade outcome as confirming if your prediction was right or wrong, you are much more likely to want to close that position early, take the profit and bask in the conclusion that you were right all along. Now I know you're watching this video to improve your trading, but to do that, especially with regards to this needs to be right issue, it's important to recognize the tendency elsewhere in normal life. How you trade is very much a reflection of who you are and as I keep saying, it is self awareness that is the key to doing an oversight and mastery over the subconscious system one mechanisms. So as you go about your normal day, try and spot this need to be right, or at least the desire not to be wrong. And it can take many forms. Not listening, not wanting to update one's opinion, debating a point just to win the argument, not wanting to apologize or admit that you were wrong, and not wanting to understand or try and understand someone else's point of view. At the end of the day, being right is a very comfortable feeling. And for the untrained mind, appearing to be wrong or fearing that other people will see you as weak is very uncomfortable. If you're not aware of this in life in general, you'll definitely bring it into the trading room with dire consequences. Taking profit early, being just one of them, averaging in and widening your stop or not using a stop loss at all are all other ways that this manifests. In trading with average in aim, you buy, the market falls and you're in a loss. So you buy some more, the market falls further and you buy again. Doing this, the price doesn't need to go back as far before you begin to see a profit. If the price continues, you often hear traders say that they were right, they were just early. No, what's really happening is the price didn't go in the direction they predicted. But they're so influenced by the need to be right, they refuse to accept the situation. System one, of course, will hijack System two and get to come up with all sorts of seemingly logical excuses to justify why this is a sensible technique. But it isn't. This is bad trading based off the primitive defense mechanisms of needing to be right. It's exactly the same with moving stop losses. It's frustrating to get into a trade, watch the market fall and stop you out before coming back up in your original direction. You sit, then you say, look, I was right, but my stop loss was too tight. So next time you widen your stop or you remove it altogether. Now, I hope you're starting to recognize that the classic pop psychology that tells you fear and greed are behind your trade mistakes is far too simplistic. They are far more subtle, yet powerful mechanisms going on behind the scenes. And and the need to be right is a big one. Now, the next factor might be more familiar to you. It's loss aversion. This is basically a universal problem that all Traders are affected by Regardless of experience, it exerts constant pressure on us all. In the last video, I explained how loss aversion explained many of our apparently irrational economic behaviors. Hopefully you remember that s shaped curve in prospect theory showing how a small amount of loss could be creates a disproportionate amount of pain. Behavioral economists describe loss aversion as a strong preference for avoiding the loss over trying to gain more. As far as this lesson is concerned, loss aversion describes your tendency to fear the loss of profits already make much more than you're motivated by the possibility of even further gains. Anytime you're considering taking profit early, it's worth remembering that your fear of losing what profit you've already accumulated is more psychologically powerful than the potential pleasure you would feel from gaining even more. A winning trade is by definition moving in the right direction. So you would think the rational thing to do is hold onto it for more profit when we don't. Behavioral economists consider it irrational, but I would argue it isn't. Don't forget that our ancestors evolved in an incredibly scarce environment short of food and resources. If it hadn't prioritized safeguarding what little they already did have and instead repeatedly took risks to acquire even more, they wouldn't have been around long enough to pass on their genes In a winning trade. We're in that same predicament. We've made a gain. We have something, and now we face the uncertainty of future price where we might lose what we've gained. We could end up with less than we started with. By closing the trade and therefore securing our minimal profit, the fear of loss is removed almost instantly. Now, just a reminder, however, loss aversion is not a bad thing. Ultimately, loss aversion, if used correctly, will stop you losing your entire account. Your fear of heights is completely rational and keeps you from taking unnecessary risks near the edge of cliffs. If it got out of hand, then it stopped you from walking across a bridge or climbing a tallist monument, then you would want to understand it and bring it into balance. But you certainly wouldn't want it removed completely. Loss aversion in trading is the same. Experienced traders have learned to understand and use it to their advantage because it's extremely useful. It motivates you to assess risk properly and protect your account. But if it interferes with winning trades that are still in the parameters of your system rules, it will severely harm your ability to maximize profits in the long term. One way of simplifying this would be to remember that trading strategies try to Maximize gains, but survival instincts minimize losses. Looking at loss aversion in terms of our sub selves that I discussed here in the last couple of lessons, keeping a mate and caring for family are in play. You will fear losing the resources, in this case money, that you need to maintain your family's safety, comfort and well being. And remember that our environment can prime us to behave in different ways and activate those different sub selves. Trading from home with your spouse or family in close proximity is highly likely to to stimulate an exaggerated fear of loss. But don't worry, that doesn't mean you need to move out or rent office space. The whole point of this course is to help you build self awareness, not overreact. Try to find a quick fix. Trading from home as we all do, simply requires a greater level of self awareness and understanding of how impulsive decisions are made. And lastly, the fear of loss is exaggerated in trading. By viewing unrealized profits as something that you own, this is something that you must detach from. Watching a trade's continuous gains and losses fluctuate can easily overstimulate system 1. Experienced traders have found ways to detach from the unrealized profits, therefore bypassing or reducing the fear of loss. The way I personally do this is threefold. One, I hide the trade terminal inside my platform, the part that shows the details of the trade like the entry price and the unrealized profit and loss. I do not want to see the dollar amount going up and down in real time because that's an emotional roller coaster. Two, my price charts are neutral exactly as you see them on the screen. Now I use bars instead of candles because I don't want to see the body of an up or down move. And the price bars are all a neutral gray color. I don't color code them red and green because that again would be a psychological priming factor. And lastly, when I enter a trade, I look at the stock loss as my starting point, not the entry level. I assume I've already spent that money as the cost of being able to play this ding. The price reversing from my entry is irrelevant to me because I've already spent the money. Technically, the price can never go against me because it's always better than my starting level. And when I trail the stop up, that's all I look at. The fluctuating price is meaningless to me. That's not my money. I'm only ever looking at the hard stop level, which does belong to me. And that of course can never get worse. It only ratchets up to improve. Those are small, subtle tactics, but they help enormously in managing my loss aversion because it's soothing my system one or certainly not stimulating my system one. Now moving on to the fourth factor, mental accounting. I introduced you to this in the last video, if you remember. It's the part of system one that remembers if a friend owes you $20 from a night egg weeks ago, or if you owe someone a favor in return for their help assembling the garden shed. This is almost never discussed in trading education, which is strange considering how much it can dominate and disrupt your decisions in trading. At the very least, it has the tendency to store the outcome for the last few trades and then aggregate an intuitive assessment of whether you're having a good or bad week or month. The key point for this factor is that because we keep different mental accounts, it changes how we act depending on the account that is being used. As an example, you may have a plan to save all of your disposable income for three years to save for a deposit for a house. Now suppose that 18 months into that plan you get an unexpected bonus at work for $5,000, or perhaps a tax refund that is technically disposable income and should, according to your plan, be added to your savings. For your house deposit, a plan was remember to put all disposable income assigned, but it's very likely you would see this unexpected money differently and it would be stored in a separate mental account. The next thing you know, you're booking holiday abroad. The mental account you place money in will alter the decisions you make. I explained in the last lesson how humans developed an intuitive accounting system that prebates money and even writing and language, and that we don't see money as completely fungible. This is entirely a System one intuitive mechanism, so it is extremely powerful and coming from system one, it is highly convincing. The running totals you have appear in your mind quickly and without effort, and it will feel like you're being logical and analytical, so you are very likely to act on this urge. In trading, it's easy to build up mental accounts of profit and loss for the week or month, or the number of wins and losses in a given period. In normal life, this is really useful. If you run a business, you might have mental accounts for which time of day or the day of week is more or less profitable, keeping track of what stage of the month you've earned enough to cover your expenses. Or you might even keep a mental account of how much you are likely to owe in Tax. And these mental accounts can be quite accurate. But in trading, keeping mental accounts of how many trades you've won or lost in a given period or your profit and loss can easily lead to taking profit early just to satisfy those mental accounts. For example, at the start of a fresh week, you might be much more able to stick to your rules properly. But after some losses as you get to the end of the week, you are much more likely to take profit early in order to balance the books before the weekend. If you're in a profit that gets your weekly balance back to break even, you'll be more inclined to take that profit, close out this mental account, and then start fresh again next week. Of course, if you're doing that, you're not making decisions that follow your system rules. Your system should dictate when to exit a trade, not a mental account. If at any point you are urged to close a trade to satisfy any sort of mental account, you are in immediate danger of inconsistent trading. And lastly, the final factor of letting winners run is the present bias. Remember, in the previous three lessons I've explained the human tendency to focus on immediate payoffs rather than long term gains. From a survival point of view, concentrating on getting through today rather than prioritizing anything else in the future is highly effective, but it's a major issue when we're trying to leave winning trades open. The present bias is usually described as preferring payoffs in the short term over the long term. Faced with the question of whether you would like $100 today or 120 in a week, you might expect that the logical thing to do is to wait for that higher amount. But most people don't. It's been labeled another irrational behavior, but let's try and understand the actual rationale. Remember, system one developed in a very uncertain world, living from day to day to survive. So it's not hard to understand why, if the future is uncertain, it's much more advantageous to have something right now. We can use what we get right now, but we might not be here to use something that we might get in the future. And neurologists have proven that we basically are hardwired to seek that immediate payoff. Our brain releases a dopamine hit purely from the expectation of a win. Just thinking about taking profits releases a chemical rush to nudge us to close the trade. And then when we do bank that profit and close early, there's another even bigger rush of chemicals as a reward, which reinforces that behavior. Experienced traders have trained themselves to detach from that instant gratification cycle so that they're surprisingly neutral about taking any kind of profit from an individual trade. To achieve that, you've got to pay attention and become aware of your feelings and what it is that you're chasing. What are you getting your dopamine hit from? Experienced traders have learned to get their dopamine hit and gratification from long term goals and achievement, rather than the highs associated with taking profit on individual trades. For instance, sticking to the system perfectly, if you execute with no errors for a full week, reward yourself with a treat. If you manage to do that for a month, give yourself an even bigger treat. You will get a dopening hit from something of value consistency. And at the same time, you will remove the focus from individual trade outcomes. Over time, that will weaken the MAO adaptive mechanism and strengthen a more beneficial one. This is how retraining works. And remember that highs lead to lows, and it's those lows that lead you to chase small heights. Take profit, get a high, take a loss, feel low. So you're even more inclined now to take profit early on the next trade to re experience that high again. And delaying gratification and detachment is like a muscle. If you don't use it, it will get weaker and you'll have no willpower. You lay in bed for two months, you wouldn't be able to walk. And likewise, if every time system one urges you to do something and you just give in, you're not exercising your willpower and you'll soon end up with none of it. Trade in is a giant exercise in delaying gratification, particularly with letting winners run. And you can practice strengthening your willpower and that delayed gratification immediately. From now on, something as simple as notice. Whenever you want to eat something or snack, try and delay giving in to that urge and gradually increase how long you can delay giving into that urge. That practice will carry over into your trading. But it's no wonder that this is hard when it comes to leaving winners to run longer. Here is a graphical representation that explains what's going on. If you're wondering whether to take option A, $10 now, or option B, $100 now, of course you would take $100, but if I offered you $10 now or $100 next week, that hundred dollars starts to disappear into a kind of mental timeline. But you'd still wait a week and take that $100, right? Maybe. But as I slowly push the promise of $100 further into the future, it's almost as if it's losing value. And at some point System one just doesn't see the value of the hundred dollars at all compared to the $10 right now. And the less money you have in your life, the more this effect is exaggerated. This is one of the reasons why people who have money make more money. A successful trader with some wealth is happy to let winners run and delay that gratification for as long as it's needed because they don't need the money right now in the short term. And similarly why poorer people don't or can't save and they struggle more to delay gratification. Short term money is far more valuable to them. So this effect is exaggerated. Survival biases are much more persuasive if you're in a state of scarcity. Just another thing you must be very self aware of when you trade. But please remember none of this is an insurmountable obstacle preventing you from succeeding. It just means you need much more self awareness to be able to catch these System One urges before they take control. All of which this course hopes to teach you. Okay, so we've covered the biggest contributors to not letting winners run. It's up to you now to do some trading with a sensible amount of risk capital, enough to trigger System One pushes, but not so much that it's overwhelming. And then pay attention as System 1 urges you to close trades early and break your trading rules. What you're looking for is what System one pushes up from your subconscious. The urge to take profit and close that trade early, contrary to what your system rules say you should be doing. Try and notice what that System One urge is the why? Is it because you feel the need to win or be right? Is it a disproportionate fear of loss? In other words, loss aversion? Or are you being advised to satisfy an arbitrary mental account like wanting to be up for the day or week? Or is it just the need to get that dopamine hit right now? Greater self awareness will improve your trading, but to get there you must understand the processes that are going on below the waterline if you're to stand the chance of not acting upon them automatically. Without self awareness, you're just going to be a slave to the confusion and cocktail of System One pushes. Ask yourself questions like what's driving this urge? You could even ask yourself, so what if I did close the trade? How would I feel? What would that change? The answer may help you understand what's driving the push in the first place. Anyway, here's a summary slide for you to use if you are making notes which I recommend you do throughout this course or pause the video if you want to take some notes there. But what I want to end this video on is a quote from Emmanuel Durnan from Goldman Sachs because I think it brilliantly expresses the reality of trading which is very different to what beginner traders believe. I'm not going to read it all out for you. You can pause the video again. It is worth a read. The next video in this course is about cutting losses. So the opposite side of the problem that we've discussed so far in this video. It's so closely linked to letting winners run. You've probably already got several questions so click through to that video when you see it and I'll explain why you have trouble accepting the loss, why you move your stops, why you add to losing positions and a whole host of additional trading stakes that people make when it comes to losing trades. So I'll see you there.