Handling losses is the hallmark of an effective trader. Many traders have heard that the average investor on Wall Street holds on to losses too long and gets out of winners too quickly. Why is that true? The average person will spend twice as much energy avoiding a loss as they will trying to obtain a profit. The reason is that the average person’s ego does not want to admit to being wrong. Thus, a common error is to hold onto a losing position hoping that it will turn around and thus avoid being wrong on the position. The reason that the average trader sells winners too quickly is that selling a winning position is a sure way to be right instantly and thus it boosts the ego.

Interestingly, both mistakes are products of the ego, and have nothing to with profits except that both mistakes take money out of the trader’s pockets. Today, we will discuss
psychological issues with losses and psychological traps to avoid.

Losing properly (by losing small and continuing to take your trades) makes winning possible. You have to learn to accept your losses, because if you are not willing to take the chance that a trade could lose a predetermined amount, you will be afraid to trade or will be scared out of a good position as soon as you get a small profit. This defeats the goal to score big when you are right.  A successful trader’s mindset must accept losses as a necessary and beneficial part of the trading processes when handled properly.

Another vital aspect of knowing when to lose is that you must never give in to the temptation to ride out your losses, which amounts to saying to yourself, “It will come back”. That type of thinking has ruined many traders. In other words, you must have the discipline to always cut your losses or keep them small. This is the main thing that will allow you to say in the game long enough to become successful.

You must keep losses small and avoid the hoping or praying stage that a loser will come back to breakeven. Breakeven levels are deadly reference points on losers. Do not liquidate a winner to keep a loser. Start liquidating not only when wrong, but when not right. This is an important distinction, because you should study whether or not your system usually produces profits within a certain amount of days. If you find that your system is profitable within the first 5 days in 80% of winners, then it may be a good idea to exit if not profitable within 5 days with that same system.

Psychological Traps to Avoid When Trading

1. Trading defensively after a loss
2. Trading only once everything looks “perfect”
3. Not following initial reasons during trade
4. Not following price stop or time stop
5. Not taking action after analysis complete and opportunity presents itself
6. Not keeping a Trading Journal on all trades and lessons learned
7. Trading an old uptrend is too obvious
8. Letting others’ opinion affect your analysis of the trade’s actionability
9. Taking a 100% loss on an options trade.
10. Taking 3 losses in a row totaling 100% or more on options trades
11. feeling out of control while trading
12. Fear of missing out
13. Fear of losing
14. Fear of leaving money on the table

In summary, avoid the classic mistake of traders as well as the ones listed above.

Price Headley is the founder and chief analyst of BigTrends.com.