Asymmetric Risk- Taking. Are you guilty?

Asymmetric Risk- Taking. Are you guilty? 

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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 ofletting 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?

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

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”

What should you know about Forex Signals ?

Six steps to improve your currency trading: First step

step 1: Strategize, Analyze and Diarize:

Successful professional traders do three things that amateurs often forget. They plan a trading strategy, they follow the markets, and they diarize, track, and analyze each of their trades.

1. Plan How You Will Trade
   You may have heard the adage, "if you fail to plan, you plan to fail." This is particularly true in Forex speculation.
   
   Successful traders start with a sound strategy and they stick to it at all times.
• Choose the currency pairs that are right for you.
  Some currency pairs are volatile and move a lot intra-day. Some currency pairs are steady and make slow moves over longer time periods. Based on your risk parameters, decide which currency pairs are best suited to your trading strategy.
• Decide how long you plan to stay in a position.
  Based on your currency pair selection, plan how long you want to hold your positions: minutes, hours, or days. Remember that depending on your account type, having open positions at 5:00pm Eastern Time may incur rollover charges.
• Set your targets for the position.
  Before you take a position you should establish your exit strategy. If the position is a winner, at what rate will you cash out? If the position is a loser, at what rate will you cut your losses? Then, place your stops and limits accordingly.
2. Follow the Forex Market
   Use Forex charts and Forex news to monitor market information and technical levels that affect your positions.
   
   
   • Use Forex Charts
     Charts are an indispensable tool to improve trading returns. You can easily recoup the money spent on a charting package from a single well-placed trade based on the analysis from professional charts. Check out XE Charts. Please keep in mind that forex trading involves a high risk of loss, and no guarantee is made that the investment on the charting applications will be recouped.
   • Follow Forex News
     XE Forex News provides breaking Forex news on economic reports and political events that influence the currency market. You can access detailed market commentary and trading strategies from experienced Forex traders.
3. Keep a Forex Diary
   Most traders fail because they make the same mistakes over and over. A diary can help by keeping track of what works for you and what doesn't. Used consistently, a well-kept diary is your best friend. When keeping your diary, make sure that it contains at least the following:
   • The date and time you took the position.
   • The rate at which you took the position.
   • The reason you took the position.
   • Your strategy for the position.
   • The date and time you exited the position.
   • The rate at which you exited the position.
   • Your profit/loss on the position.
   • Why you exited the position. Did you follow you strategy?
   Once you learn to recognize successful trading patterns, you will be able to spot them when they return.

Be aware that trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.

Source: http://www.xe.com/currencytrading/improve.php

What should you know about Forex Signals ?