The long answer is a deep and twisted look into behavioural finance, a subject that will explore why we decide to hang on to a losing trade. The emotional and psychological reasoning that helps us cope with bad decision making. Eventually we find a way to justify what we are doing even though it is technically wrong. The corrective action only comes much later. If you need a deeper insight into this and possibly reading a book on behavioural finance are listening to an audiobook like reminiscences of a stock operator by Edwin Lefevre, should do the job.

The short answer is to cut losses short. A winning strategy simply requires you to have a positive risk reward on your trades. Make more money on the winning trades, lose less on the losing trades. The quick and easy way to do this is to simply look at the mark to market amount and consider whether it bothers you. At the smallest botheration close out the trade, and re-enter it on a fresh trade signal that reaffirms your original view on the security that your trading. More often than not if you can say that the original reason for buying the security no longer exists, or that it did not behave in the way you anticipated soon enough, it is time to get out.

It is sometimes similar to taking a painkiller when you suffer extreme pain or a headache. The direct pain will not go away unless you close out your losing trade. The subsequent pain is similar to what you feel when you put a block of ice where you have been hurt, there is a short-term numbness that eventually fades away and prepares you to be able to think straight again.

Decisions that you take while still suffering the pain can often be wrong as they are aimed at trying to prove that you are right. The market has already taken care of that part. Accepting that you are wrong, Is the big step towards moving on. Once taken you will not only close out the losing trade, but quickly move on to prepare to take the next one.

More often than not it is not the methodology that you follow that is wrong in the identification of winning trades but the execution that kills the end result. You are only going to be right 6 to 7 times in every 10 positions that you take. Thus, not trading or investing is not an option. If you want to play this game you have to be prepared for the idea that 30 to 40% of your trades or investment decisions are going to go wrong. Achieving a high risk reward ratio then is a function of closing out those 30 to 40% trades as soon as they become pain points or prove that the reason for entry has been proven wrong.

If you start out with the belief that you are going to be right hundred percent of the time to avoid losses then you will never achieve the end result. There is no holy grail because the stock market is a probability game. Avoiding losses is a process of winning and losing trades the summation of which over a period of time needs to end up being positive. Trying to be right hundred percent of the time is an ego battle that you are unlikely to win.

The truth about the markets

Rohit Srivastava