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A trader I work with, Glenn, sent me this note:

Adam, I think this would be an excellent blog post because when it happens it is so frustrating. I got triggered long, and price came within 3 cents of my 1.0R [R = initial risk on the trade] take profit and price reversed to a full 1.0R loss.

Take a look at the specific (and dramatic!) chart that Glenn attached to his plea, showing a case where he entered a pullback in NWSA and was stopped out on the same day. Though this is a good example for discussion, the idea generalizes to any style of trading that uses a target, whether fixed or discretionary. Here’s the real question:

A missed profit in NWSA?

How do we deal with trades that come close to our target but don’t quite get there? What to do?!?!

The right answer, as usual, depends on who you are as a trader and how you like to trade, but I think we can find a better answer than leaving it there. One reason this is so hard is that profit taking is difficult because the emotion attached to winning and losing isn’t quite as predictable as we might think. \

Pain of loss is asymmetrical. For many traders, when, where, and how you lose $1 affects how you feel about that loss. In a simple model of the world, it’s easier to understand how people feel about wins and losses because you could just assign some type of “emotional scoring system” to money lost and money won. Yes, we might understand that it’s different for everyone, and the pain of losing a certain amount of money might not offset the reward of making that same amount, but I think it’s a lot more complicated than that.

One of the common struggles developing traders have is that they work first on executing their stops and diligently taking their losses. I’m willing to bet that most serious, developing traders learn to do this very well and many of them can take those stop losses without undue emotion. (We are human, so we always will have some emotional reaction to trading.) However, many of those traders then find themselves making very bad decisions with profit taking, and doing things like getting in trades with $10 targets and then taking $0.20 profits as soon as they get nervous.

I think this is one of the great, underappreciated struggles of learning to trade: learning to take profits is hard! So many of the mistakes that developing traders make center around this issue. Glenn is ahead of the game because he’s focusing on this problem, and he just happened to have a very dramatic lesson on this day from the market. Let’s see if we can find some bullet points that might help him (and you) along a bit.

  • Sh*t happens in the market, and sometimes sh*t happens to you. It’s very tempting to rush to redo our rule set after one great winning trade or one painful losing trade, but it’s also important to respect the randomness and variability in the market. Sometimes bad things happen to good traders. Sometimes bad things happen to good trades. It’s hard to know when we should react with a rule change and when we should simple let the system work, but one example like this is not enough evidence (probably) to make a change. It’s entirely possible that this was just one unlucky trade. (Note that “sh*t happens” is another way to say “the market is highly random, even with a great setup.”)
  • The discipline of process is more important than the outcome of any one trade. Glenn is going to make his fortune in the market because he finds a small edge and exploits it over and over with perfect discipline while building his trading capital. That’s how we make money in the market, not by “figuring it out” on any one trade, or getting ahead of any situation. We need a repeatable process, and that’s the most important thing. If we have a good process, some very good and very bad things will happen to us, but the sum of our trades should be positive. We have to understand this and have faith in the process, so Glenn did a good thing here, at least in this sense.
  • There’s a difference between what happens on the entry bar and what happens later. The question Glenn is asking is basically how to deal with trades that come very close to your target and don’t actually get there. I think there are two answers: 1) it’s ok to take profits a little early or 2) never take profits early. The case for #2 is that a market sitting at 0.9R profit is much more likely to tick the 0.1R to your 1.0R target than it is to reverse all the way to your entry price. Regardless, it will sometimes go back to your entry price and that may just be something to accept within context of your system. The case for #1 is that #2 is really hard psychologically. The answer that ties both #1 and #2 together is that you must have a rule for this in your trading system and follow that rule; don’t make it up on every trade! In this case, we might think about a trade that grinds toward our target and can’t quite get there, day after day in the trade, or one that teases us on the entry day. It’s possible that these are two very different situations that might require different rules.
  • Big bars show shifts of market dynamics. Glenn got exceedingly unlucky in that he entered a trade on the same day this stock had a giant (Trump-driven) move in both directions. We can see from a glance at this chart that this stock tends to have some large moves, and they tend to have followthrough. We need to read this element of the stock’s behavior (which is normal, by the way) and know that chasing another long trade here would probably be a mistake. Along that same theme…
  • Don’t let a loss provoke mistakes. Glenn had a losing trade, and that’s ok and normal. What we must, at all costs, protect against is letting the market provoke us into making another mistake: going revenge trading in another market, just reentering on the stop out, jumping down and trading lower timeframes (thinking that we are “scalping”), doing the next trade on larger size, not taking subsequent trades in other stocks, etc. These are all examples of errors that can follow an emotional event in the market. As always, the answer is simple to write but sometimes difficult to execute: simply follow your rules, no matter what. Just follow the rules.

This is a good example of an unfortunate trade, and it’s one you should probably think about. It’s also a case where the right answer might be different for different traders (given risk tolerance and psychological make up.) Should Glenn have moved the stop to breakeven or taken a small profit on the trade? It’s easy to say yes, but it’s also easy for that mindset to lead us into intraday trading. Above all, the discipline of process and consistency are what matter most, and a losing trade is simply a step on the road to our eventual success.