Asymmetric Risk-Taking, Are You Guilty?

Why we cut profits early and let losses run? In this article I would address the real trading psychology behind it. Lets start with a simple test !

Most traders new to Forex are often guilty of letting their losses run and cutting their profits short, even experienced traders do it every once in a while. Before we begin, answer the two questions below. When faced with a scenarios below which option would you prefer?

Scenario 1:

A. 80% chance of winning $2,000 and a 20% chance to win nothing
B. $1500 Profit for sure

Scenario 2:

A. 80% chance of losing $2,000 and a 20% chance to lose nothing
B. $1500 Loss for sure

Most traders would chose Option B in Scenario 1 and Option A in Scenario 2. Compare these results with your own answers. If you chose the same then unfortunately you will be among 95% of traders who fails at Forex. Read Forex Loser’s Checklist, and see if you qualify. Lets look at psychology behind your decisions.

The two scenarios are quite interesting. Our perception of gain and loss changes our behaviour. When the options of a risky scenario involve profits, traders are risk-averse (risk-avoidance); however when options of a risky scenario involve losses, traders are risk-seeking. The other words, traders tend to seek risk in face of possible loss and avoid risk when profits are at stake.

This asymmetrical way of risk-taking has great implications on trading decisions we make as a trader. Our decision are based “subjectively”, taking in account recent events rather than looking at overall net trading balance. Let me explain:

After a profitable trade, the decision to close trade and take profit on next trade depends on gains made on previous trade. A trader starts to think ” I’ve made enough on the first trade, lets not lose it all and give away all the profits. Take early profit and call it a day”. At the same time, on a losing position trader delay cutting losses and hold on to trades hoping that it will reverse. The result is that trader realize profits way too early while allowing losses to accumulate.

A professional trader just need to act opposite to typical human behaviour. By considering the impact of losses on net trading balance and not on recent history of trading , a trader can make right decision of letting a losing position go early while keeping the profitable position running. Trading Robots have this advantage over manual trading as they help avoid implications of trading psychology.

Another interesting aspect of trading is the impact of losses on our minds. The feeling of losing an amount is much worse than pleasure gained from winning the same amount. Hence traders, hate losing 10,000 more than they love winning 10,000. Psychologically losses have twice the impact, no wonder why a trader don’t want to close a loosing position and willing to risk more.

A good trader is not a trader who makes millions in fraction of a second. A good trader is one who know where to cut his positions. It is not about making money; it is about losing as less as possible when we are wrong. Thus managing the psychological asymmetry in risk-taking is the key for succeeding as a trader. Bottom line “An experienced trader stands out from a new trader not by how he makes money, but how he loses money”

Do you agree? Leave comment below.

Discover Your Forex Trading Niche

Forex Trading Niche Someone once said “It’s not whether you can be a good trader, it’s whether you can find the trading that’s good for you”

Give a bunch of traders a proven successful system, you can bet that not everyone will make money from it. We know the system is not wrong. So what is it that makes a person successful at trading? Lets find out.

In my opinion success comes when there a perfect fit between the person and his/her trading strategy. If you are still struggling at making profits from trading then it is not because you are lazy but perhaps you are simply trading in a way which is not in sync with your personality.

Points below will help you to find your own Forex Trading Niche:

Trade Different Time Frames

Have you tried trading intra-day, swing and position trading? If not, then how you know that the current timeframe you are using the best one which fits you.

From experimenting I found that I mentally handle swing trades better than trades that last for months or few seconds like in case of News trading.

Trade Different Styles

Most people dive straight into technical analysis based on indicators. How about fundamental based trading, or even news trading (not that I recommend news trading).

I’ve played around with more indicators than you can imagine. Bottom line, I was getting no where; there is no end at finding the best combination of indicators that would work. I stopped once I found my peace in Price Action and it is where everything came together.

Trade Different Markets

Why trade Forex only and not Stocks, Commodities and Futures? Unless you attempt to trade all these markets how would know which one is best for you.

I am guilty of this myself. I’ve never traded any other market. I may be not performing at my best and I would never know until I try all other markets. The good thing about Price Action strategy that I currently use is that I can apply it on any other market. I’ll save this one for 2011 New year resolution.

Make changes to your trading method

One would think that once they have found the best strategy then there would be no need to make any changes ever. That’s just not true. On the contrary most professional traders constantly tweak their systems to match current market conditions.

I’ve modified the current strategy several times in the past, and I’ll continue to do so as I seem fit. On the other hand I keep working on variations of the same strategy to see if there is more I can get out of it.

Trade Long Enough

This point brings everything together. It would take time to try all the combination above. If you just got started in trading then it can take some time before you discover your trading niche.

I did not succeed for the first two years, I was barely able to keep my account above par. I think I was too adamant to follow any gurus at the time, now looking back I think I should have followed someone which could have shorten my learning curve.

In Summary of discovering Forex trading niche, one would naturally excel when they find the right market, the right strategy and the right fit with their personality. On the side note, remember it is the journey that matters so don’t forget people you meet on the way :)

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