How to Let Profits Run?

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2 Sep 2015

“Hi, I have been trading for a few years now, and have always found it quite difficult to run my profits. I often have a target in mind but find myself getting out much too early, sometimes because of the noise in the market, sometimes because I am just worried about giving back the profits I have. Is there anything I can do that can help me to take a bit more out of my trades?”

Running profits is a challenge that many traders have, and there are a number of reasons why this is the case:

1. The disposition effect, from behavioural finance, shows a tendency in people to become risk averse in a situation of gain.

2. From an ego perspective it is good to take the money that is on the table, it confirms you were right, you made money.

3. ‘A bird in the hand, is worth two in the bush’ – or inter-temporal discounting, people are more likely to take a short term gain, rather than wait for a future one, especially if the future one is not guaranteed. Would you rather have $100 now or wait a month for $110? What about if it was a possible $110 in the future, but not guaranteed?

4. The uncertainty of knowing whether price will keep going to your profit target, or whether it will retrace and move back against you (which is often then experienced as a loss) creates a feeling of anxiety which for many traders in uncomfortable. To get rid of this feeling of anxiety and discomfort traders exit the trade.

5. The threat of losing money can often activate your stress response and defensive ‘survival’ thinking leading to ‘flight’.

So there are a number of possible ‘psychological’ reasons why you may have a tendency to take profits early. On top of this we have to remember that you become good at what you practise, so if you have been trading for a while and always taken quick profits then this will be a skill that you have been practising and you will have become pretty good at it, so it will become automatic, a habit. There are also situational factors that affect a traders ability to run profits – such as following a big loss, or when they are in a losing run, or they feel a greater urgency to make money – where they may become overly focused on profits and very sensitive to loss which induces profit snatching.

Without knowing the specifics of your own trading history, strategy/approach or situation I am going to offer a few different possible approaches that could potentially help you to run your profits further.

1. Plan for Profits

When you enter a trade, write down what your profit target is and why you have chosen that price/level, and perhaps even how long you think it will take to get there. This helps to give you a little more commitment to the trade, and also allows you to check back after you have closed your position to see how much profit you took out of the trade against what you had originally planned for.

2. What Gets Measured Gets Done

If you are not already, start keeping a trade log. Log your trades, the entries and reasons for them, your profit and loss levels and expectations for the trade, your exits and the reasons for your exits. Also, monitor what happened after you got out of the trade – did the market go to your expected profit target or not. Logging trades in this fashion will help you to objectively assess how frequently you are running your trades, how much you are taking out of your trade against what you planned, and how often after you got out of a trade the market went in your favour, or went against you – whether maybe you are actually getting out early but that was the best decision. In a sense you are measuring the quality of your judgement.