Section WidgetIf you’re like most traders, you may be thinking you are most vulnerable following a losing trade and especially after a series of losing trades. While it is true that revenge trading – an explicit and reckless attempt to win back the money you just lost – is one of the most common killers of trading accounts, there is another time that can leave you just as vulnerable, if not more so.
I would argue that traders are most vulnerable to taking a loss immediately following a profitable trade. This is especially true if the profit was a large sum of money or if you experienced a string of profitable trades.
After all, the most dangerous situations in life are often those that are least expected. And when you’re on a hot streak, it’s far too easy to begin discounting the risks involved.
Surprised?
If so, go ahead and take the requisite time to look back at some of your largest winners. Chances are they were immediately followed by a loss or even a string of losses.
There is a very good reason for this, three reasons in fact, that will be discussed in this article. We’ll take a look at why this tendency occurs and what to do about it so you can stop giving profits back to the market.
Overconfidence, Meet Negligence
There are two main factors that help explain why you are most vulnerable to taking a loss immediately following a profitable trade. To be succinct, it all boils down to overconfidence and negligence. Of course these two have a lot in common and are often byproducts of one another.
But before we get too far along, let’s define the two terms and at the same time make them applicable to Forex trading.
Overconfidence: When someone has more confidence than they should have based on the situation and they misjudge their ability or opinion.
I love this definition of overconfidence because it ties in perfectly with trading. The “misjudge their ability or opinion” part of the definition is one of the most common pitfalls among Forex traders. After a winning trade, many traders begin to think they are unstoppable and that they know what will happen next in the market.
If you have been at it long enough to experience the droughts that are all too common, you are well aware that anyone who tells you they know what will happen next in the market is either lying to themselves, to you, or both. It simply isn’t possible, nor is it necessary to become consistently profitable.
Negligence: Failure to exercise the care that a reasonably prudent person would exercise in like circumstances. (Source: Merriam-Webster)
An example of negligence, or neglect, would be risking too much on a single trade. Another example could be something as simple as over-trading, where your patience runs so thin that you begin taking “B” setups rather than “A+” setups.
To be clear, both overconfidence and negligence can occur outside of the period of time immediately following a profitable trade. However, there is no doubt that these two are fueled by the post-trade euphoria that many traders experience.
Why does this happen?
There are a few elements that can help explain why we tend to slip back into bad habits following a profitable trade, but none are more prevalent and destructive as overconfidence.
Immediately following a winner, you feel on top of the world, as if you can conquer anything. This is especially true after a large profit or a string of profitable trades.
And while confidence is a quality present in every profitable market participant, beingoverconfident can have devastating consequences.
Being overconfident in your abilities causes you to begin thinking that you know what will happen next in the market. Instead of evaluating a setup from a risk-based perspective, you turn to a reward-based perspective where the risk involved is an afterthought.
This way of thinking is detrimental to your longevity as a trader.
Negligence, on the other hand, can be thought of as a byproduct of overconfidence. This is where you begin risking too much and trading too often. Once you begin traveling down this path, it’s a sign that overconfidence has started to adversely affect your trading.
Problem is, you aren’t likely to see the danger until it’s too late.
The House Money Effect
Another common challenge many Forex traders face following an increase in their account balance is taking ownership of the new funds.
What do I mean, exactly?
When your account balance goes from $5,000 to $5,500, it can be all too easy to view the additional $500 as “house money”. This is more commonly known as the “house money effect”whereby traders take on greater risk when trading with profits.
This too can be classified as negligent behavior as it relates to proper money management.
Don’t get me wrong, no trader on earth intentionally gives back the money they just made. But the truth is, many traders have a hard time seeing those new funds as their own and something they need to protect at all times. This leads to the aforementioned destructive behaviors such as over-leveraging your account and over-trading.
In essence, the house money effect conditions us to lie to ourselves. It gives us an “out” in case the next setup fails and we lose all of the profits we just made. By viewing the recent profit as house money rather than our money, we are subconsciously protecting ourselves from any emotional discomfort that might result from a future loss.
The good news is that this is completely curable, which we will get to momentarily.
But first, let’s go back to the example of making $500 in your $5,000 account. The ideal mentality at this point is to fully accept your new account value of $5,500. You should see it no differently than you did when your account was $5,000 comprised of your hard earned money.
The truth is that very few traders see it this way. Instead, they see that newly added $500 as gambling money – something they can risk on the very next trade and not feel too bad if they lose all of it.
Trading is a very different way of making money than just about anything else out there. One reason that many individuals have a hard time fully accepting the money they make as a trader is because it requires little effort.
Sure, you have to put in the screen time to understand the basic concepts, but for the most part there is little effort involved from the time you place a trade to the time you take it off. In many ways, it can be too easy to make money from any one position. Regardless of whether the profit was generated through luck or skill, the lack of effort makes taking full responsibility for it that much harder.
I doubt the person who digs ditches for a living is as quick to dispose of their $1,000 check as the Forex trader who sits in an air conditioned house pressing buttons on a keyboard. That’s the point I’m trying to make here.
Understanding what you’re doing wrong is the very first step to correcting it, but until you understand why you do it, you won’t be able to consistently grow your trading account.
A Simple Solution
Ready for the simplest and most effective solution in the history of trading?
Here it is…
After booking a profit, walk away. No really, that’s it. The best thing you can do to put an end to the vicious cycle of giving back profits is to walk away from your computer after closing a profitable position.
I have previously written about the power of doing nothing and the same concept applies here.
By having a rule that requires a break after a profitable trade, you allow yourself the time needed to collect your thoughts, which in turn allows any euphoric thoughts to dissipate. It doesn’t need to be a long break, just 24 hours can work wonders, but a break of some sort is a must.
During this time away, be sure to reinforce what you’ve come to know about trading, namely the fact that you are never in complete control of the market and you will never know what will happen next.
And regardless of how much you made on your last trade, it doesn’t mean you are the best trader on earth (I say this in humble fashion as overconfidence used to be one of my biggest downfalls).
Last but not least, reinforce the fact that your account has grown. That 10% profit you just made is now your money, not house money. Your number one job going forward is to protect it, not make more of it.
Final Words
If you want to remove yourself from the viscous cycle of giving profits back to the market, taking a break after a profitable trade is a must. This can be anything from a few hours, a full day or even several days, whatever you need to brush off the euphoric thoughts.
By entering the market immediately following a profitable trade, you increase the odds of negligent behavior such as risking too much or trading too often.
Remember that time is on your side. Successfully navigating the Forex market is a process, not a project. And there’s no prize for finishing first, but there is punishment for reckless behavior.
Unrealized profits, meaning that which has not yet been booked, do not belong to you. On the contrary, realized profits, or that which has been booked, is very much yours. This means that the next time you sit down at your trading desk following an increase in account balance, your number one job is to protect that profit.
Repeat this process enough and you will eventually grow your account, one profitable trade at a time.