Thoughts, Trading

Exiting a Winner Early at a “Good Price” Is a Mistake

One of the mistakes I used to do is to exit a winning trade early at what I thought to be a “good price”, i.e. a price at or higher than the Ask (for longs), or a price at or lower than the Bid (for shorts).

The Process

Here is how it usually went:

  1. I would have a winning trade with open profits, say its a long
  2. After some time, I see that there is heavy resistance preventing the market from going up further. Large lots were being thrown at the offer, but the offer doesn’t lift. A few seconds later, some large lots start to hit the bids, suggesting that sellers are starting to push the price down.
  3. I would “feel” that a loss is coming, and would impulsively place a sell limit order either at the Ask or say 1 – 2 ticks above the Ask. I wanted to get out, yet I greedily wanted to get out at a high price. I rationalized this action by saying to myself: the sellers are holding this level, but the buyers might still break through 1 – 2 ticks more before the sellers turn the price down, so why not I place a limit order 1 – 2 ticks above, and take that opportunity to sell out when the levels are cleared momentarily. And since this is a resistance area, price would probably stay around for some time, so I would still have an opportunity to get back in later if price doesn’t drop. Then I start to hope that I will get lucky, that price would just spike up 1 – 2 ticks before turning down.
  4. Usually one of two things happen
    • Price suddenly breaks out with large lots clearing the offer and price moving rapidly up.
      • I then get stuck in indecision knowing on the one hand that I shouldn’t be chasing a runaway market, and on the other hand the fear of losing out grips me and I know that I made a mistake by selling early.
      • Usually when price is just above the resistance, I will be hoping that price will come back down, and I will be very uncomfortable in buying back at a higher price than the price I just exited, so I would not do anything.
      • Eventually as price keeps on climbing however, the fear of missing out would win and I would impulsively chase the market. Then either the market will start to turn down, or I will be shaken out by minor fluctuations (since my logical stop is far away) before the trend continues.
    • Price backs off a little, I panic and exit, then price turns back up, clears the resistance and continues on with the trend while I get stuck in indecision. Rinse and repeat as above.
    • What about the case where I manage to sell near the top of the turn? Actually when I try my best to recall now, I really don’t remember such a scenario. Either the emotional footprint of such an event is small, or it happens really rarely. I suspect it’s the latter.

As you can see, the process was filled with greed, hope, fear, impulse (lack of self-control / discipline), faulty rationalization, and of course, a healthy dose of monetary loss.

What Went Wrong?

Now, what went wrong in that process? Let’s try to abstract the process to figure out what went wrong:

  1. There were signs of sellers stepping up on the tape – FACT
  2. My emotional mind reacts with anxiety, my logical mind rationalized it by forming a view that price would turn down so I need to sell – WRONG!
  3. I lowered the threshold of taking that action by saying to myself that the action is reversible, since price would likely stay in this resistance area for me to get back on – WRONG!
  4. I embarked on the wrong action and boarded the expensive emotional ride.

A Dive Deeper

OK, let’s go deeper to see what is wrong with steps 2 and 3 above.

  1. You don’t know who the winner of the fight will be. Nobody knows, not even the big boys doing the fighting right at that moment. Nobody can consistently predict every single market swing, which is what you are trying to do right then.
  2. Fighting between the bulls and bears is what the market IS. You expect to see that all the time. Bears win during retracements in an uptrend. Bulls win during retracements in a downtrend. Are “signs of sellers stepping up on the tape” good enough to make a high probability market bet that price will go down right that moment? NO!!! What has the bears done so far to prove to you that they are strong enough such that you should bet on them? NOTHING!! They have been losing so far in the uptrend, and ‘signs of life’ means nothing! so having a view that the bears will win is ridiculous.
  3. By placing a sell order above the Ask, you are selling when the market has just proved to you that it is strong! Think about it! Just at the moment the market tells you that it is strong, you sell it!?
  4. As I mentioned in a previous post, your exit is a countertrend trade. Most countertrend trades are low reward (nature of the market) and high risk (because accuracy here is extremely important). Why do you want to take a low reward, high risk trade when you are in a winning position in an uptrend?
  5. On the reversibility of the action, it sounds true in theory, but it doesn’t work in practice. You frequently see resistance zones that hold for a brief moment before price blasts through, never to look back. And even if price sticks around to allow to you re-enter after you exited, what do you think you will  be doing? You will not do anything while still hoping that price will drop. Even if you set a time threshold to re-enter, you bring on another thing into your trading plan to deal with adherence issues.

A Dive Deeper Still

Let’s dig even deeper now, and examine the root of it all, the anxiety that you feel when you see sellers showing some strength on the tape.

  • Why do you feel that anxiety? Because your mind extrapolates what it sees and projects a future where the bears win and you lose money (be aware that humans have a natural negativity bias). The emotional mind magnifies the immediate “weakness” while minimizing what is further in the future (i.e. to focus on the bigger picture of the trade itself), this is similar to the phenomenon of temporal discounting in psychology.
  • You cannot stop the mind from doing that automatically, but you can challenge its underlying beliefs to guide the mind towards reaching a different conclusion when presented with the same stimulus.
  • Now is that underlying belief reasonable? that sellers showing signs of life means that price would go down?
    • For the immediate term, it is unclear. You are in an uptrend, there is a chance that the bulls will clear that resistance, but there is also the chance that this is the start of a retracement. You can’t put a high probability on either scenario.
    • For the life of the trade, no, as written above, the bears have been clearly losing to an extent that you have determined that the trend is up. The bears have not broken supports, they have not held lower resistances, it is reasonable to conclude that the upside has a higher probability.
  • The second part is with respect to management of the trade:
    • We want to maximize the P/L of the trade, not the open P/L from tick-to-tick. When choosing between the action to take, we should be thinking: what is the better / more likely outcome for the trade P/L. Even if an immediate loss is more likely in the next few ticks, by taking the actions that we take, how would that impact the outcome of the trade P/L eventually? If the impact is negative on the trade P/L, we should not be taking it.
    • So even if the immediate likelihood is that the price would go down, if we take a countertrend trade in the form of an early exit, that will negatively impact the trade P/L as it brings on board issues of chasing the market, re-entry, cognitive dissonance in not following a logical trading plan, etc.

The Remaining Ingredient

So all this logical reasoning is well and good. However, you can’t just think your way into changing a behavior. It is not as easy as the logical mind giving a command and the emotional mind immediately obeys. That doesn’t work. The emotional mind needs to be gradually trained to instantly produce the right response the next time the same situation occurs (if you are doing intraday trading, you need that instant correct response, if you are doing longer-term trading, you can still think yourself out of the situation). How do we do that? Rewards!

Just as with every behavior, we tend to repeat it if we get immediate gratification when we do that behavior. There are two rewards: One where the trade is nicely profitable after you’ve stuck with it without exiting early. Another is for you to congratulate yourself, pat yourself in the back, feel proud and happy that you did the right thing! Do that right after a good trade, and also during trade review after your trading. That’s it. This also serves as an example of what I mean in my previous post about maintaining awareness during trading, and using the information gathered to improve your trading as part of each trade review process.



5 thoughts on “Exiting a Winner Early at a “Good Price” Is a Mistake

  1. I hear ya. Been there done that. From your posts, my impression is you don’t have confidence in your setup or trading system. Thus, a series of losing trades can quickly throw you in an emotional spin.

    I don’t pretend to be a guru. I am a day trader and I was trading like you a while back. I just want to share that I finally overcame the stage you’re in when I realized that my emotional problems were brought about because of my inconsistency with my trading. I have to give credit to two groups of traders who influenced me greatly but I’m not going to mention them here.

    Basically, I studied price action first to understand why price moves. Then, I archived setups that made sense to me (meaning I understand the setup and why it works) in a playbook. My archive also included trade management with reasons on when to exit the trade. Once I had a playbook of my favorite setups, it was easier to tackle my emotional issues (like fear and greed) because I now have confidence with my setups. I know that I have a playbook that can give me one winning trade which can easily cover up several losses and then some. With confidence in my setups, I was able to focus on being calm and unemotional each trading day because by being calm I am able to think clearly and execute my trading plan. Everyday, I accept that each trade can be a winner or loser and if the trade doesn’t work out, I move on to the next trade. When I see my playbook setup, I tell myself I have to take the trade without hesitation and see if it will be a big winner or a small loser. If I miss out on a trade because it did not set up properly (based on my playbook), I dismiss them and focus on finding the next setup. I hope you would find something useful in my comment.

    Posted by RC7rader (@RC7rader) | April 1, 2014, 5:34 am
    • Thanks for sharing RC7rader, your comments are very useful. The post documented my learning journey as I developed my own setups. I absolutely agree with you that one needs to develop their own setups that make sense to them. These setups should have clearly defined rules that cater for all situations to minimize emotional creep. With well defined trading plan and setups, psychological issues can then be tackled.

      Posted by whatheheckaboom | April 3, 2014, 12:18 am
      • stumbled on your blog. have you got an email address?

        Posted by covetousmusings | April 29, 2014, 1:29 pm
      • Hi Covetous Musings, I’ve added a contact page (link is at the top menu bar which contains links to other pages) if you need to drop me a note. Thanks.

        Posted by whatheheckaboom | May 4, 2014, 2:05 pm
      • Hi Covetous Musings, I got your note. Yes I agree its different trading professionally at an institution vs. trading on our own. There’s a tendency to relax on trading discipline when you don’t have to answer to your boss/company/colleagues. Thanks much for your comments!

        Posted by whatheheckaboom | May 18, 2014, 12:33 pm

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