In this episode of Truth About FX, Walter talks about the disadvantages and dangers of taking profits too early, the importance of arriving at a breakeven, and why you should always keep your trading psychology in check before making these decisions.

http://media.blubrry.com/truth_about_fx/content.blubrry.com/truth_about_fx/TAFX_-_EP23_Should_I_Take_Profits_Early.mp3

Download (Duration: 04:16/ 4.90 MB)

In This Episode:

00:35 – tempting to do

01:14 – tricky part

02:14 – a big mistake

01:13 – numbers against you

Tweetables:

The way around it is to set your stop loss to breakeven. [Click To Tweet].

It feels good but in the long run you’ll see the disadvantage.  [Click To Tweet].

Your risk of ruin can skyrocket.  [Click To Tweet].

Hugh: Hi, Walter. Today’s question is do you ever close out a winning trade early just to offset a losing trade? So, you take a guaranteed winner so just that your PNL is positive.

Walter: This is really a tempting thing to do. It’s probably more common if you’re new to trading but I believe it to be a really big mistake.

Here’s why: if you keep taking early profits, what you’re doing is you’re whittling your way at your reward/risk ratio. Now, your reward/risk ratio and your win rate work hand in hand to give you your expectancy which is how much money do you expect to make with your system.

Most traders understand that. If you run through the formula, you’ll know what your expectancy is given your supposed win rate and your supposed reward/risk ratio if you’ve done any sort of backtesting or have an idea what to expect.

Here’s where the tricky part comes in. If you actually do this and start taking profit early then — let’s say that you have a system where your reward/risk ratio is let’s say, 2. 2.0 for every dollar you risk — you’re making two dollars on average.

What happens is you take profit early and that starts the fall down — maybe it’s down to 1.85 then it gets down to 1.75. This is simply because you’ve seen too many trades go in your direction, not hit your profit target, and then they come back  and either stop you out or hit your break and stop. You get really frustrated and you feel like you should take profit while it’s there for you.

The problem with this is — and most traders don’t realize this — your risk of ruin can skyrocket. In other words, the chances of you running into a horrible drawdown to the point where you throw into the tower and say “that’s it, I quit.” That goes way up if you start doing this with your trade.

What I suggest traders do is to simply don’t. Don’t do this. It’s a big mistake, really. The way around it is to set your stop loss to breakeven. Some people will say “I know you know how I trade, Hugh. I like to move to breakeven generally, quickly”. I know some traders don’t like that.

I look at those trades where it comes back and hit my stop loss even if it went within a few pips on my target.