Snatching profits and running losses

Lesson 1 of 2

Are you in control of your trading?

When you trade, your positions are subject to a number of uncontrollable variables. Market movement can be difficult to predict. Fast-moving news events can switch the direction of a market very quickly – sometimes too quickly for you to react.

But while you can’t dictate what happens to the markets, you can be disciplined with the variables that you do control:

  • How much you’re prepared to risk on each trade
  • When you’re going to enter a trade
  • How you’ll exit a trade

By defining these parameters before you enter a trade, you can take greater control over how much you can make or lose – even if you can’t control whether or not you’ll win.

It’s human nature

Research shows that we’re risk-averse when it comes to making money. We’d rather grab a quick win than risk losing it. This is true in trading, with a surprisingly high number of traders ‘snatching’ profits and missing out on potentially bigger gains.

For instance, let’s say you placed a trade on Wall Street, going long £5 per point. When you check the position in the platform, it’s already in profit by say £48.

Your natural instinct would probably be to close the position and take that profit.

While you would be taking a small profit, you could well have lost out on a bigger one – if the market continued to rise even by ten points you’d have doubled your profit. It’s worth remembering that if you snatch small profits, transaction costs like spread and commission will be amplified relative to your profit – eating into your returns.

You can take measures to stop yourself snatching profits. If your analysis suggests a market will rise to a peak height, you can set an order to close around that peak and take the maximum profit you think might be available. For more on orders to close, take a look at our course on setting stops and limits.

While we seem to be risk-averse when it comes to the money we’ve already got, when we’re losing money we’re bizarrely prepared to take on a lot more risk. Rather than seeing a small loss and thinking ‘let’s nip that in the bud’, we have a tendency to believe that the loss is bound to reverse.

If you took a position on the FTSE 100 for instance, you might see an early loss of say, £87.50.

But rather than closing it you leave it open, hoping it’ll turn around. However, it doesn’t and you go on to lose even more:

You can enforce risk limits by setting stop losses. This is a sensible approach if your analysis doesn’t suggest a market will turn around. Not setting risk limits, or failing to stick to them if you have set them, and leaving your positions open means you’ll be exposed to losing more than you may be comfortable with.

If you’re prone to snatching profits and letting your losses run, you’ll probably find that you have a fairly robust win rate. You can take a look at your win rate in the trade analytics tool in My IG. You’ll find the tool on the left-hand menu of the ‘live accounts’ tab.

Once you click into the tool scroll down to find your win rate:

However, you can’t view a good win rate in isolation. Your regular small wins can easily be outweighed by fewer, larger, losses. To get a clearer idea of how your trading is performing you should also take a look at your profit-to-loss ratio.

To break even, your profit-to-loss ratio should be around 1:1. You can still make money with a low profit-to-loss ratio, but you’d need a win rate of more than 50%. Plus, if you’re snatching wins to achieve this high win rate, the more likely it is that your profit-to-loss ratio will decrease as regular small profits are offset by greater losses. But, as we discussed earlier, markets are unpredictable. You can’t guarantee that every trade will go your way meaning you can’t control your win rate.

However, by setting those parameters we mentioned earlier in the lesson – defining the amount of risk you’re willing to take on each trade, when you’ll enter and exit the trade– you can enforce a level of discipline which should help increase your profit-to-loss ratio.

You can find out more about defining your risk in our ‘controlling risk’ lesson in our course on understanding risk, and planning when you’re going to enter a trade in our course on stops and limits . We’ll take a look at closer look at planning your exit, in the context of removing the temptation to snatch profits and run losses, in the next lesson of this course.

Homework

Go into the trade analytics tool and take a look at how your trading is performing. If you have a low profit-to-loss ratio, take a look at your trading history and try to identify positions where you’ve either let your losses run, or snatched a profit. Think about how you could’ve added stop losses to avoid this, and see if you could apply these to any positions you currently have opened.

Lesson summary

  • Take greater control of how much you win and lose by defining your risk and when you’ll enter and exit trades
  • It’s common mistake made by traders to let losses run and to snatch small profits
  • You can’t view your win rate in isolation, and should aim for a healthy profit-to-loss ratio
Lesson complete