5 Strategies to Protect Your Trading Profits

You’ve worked hard to understand the financial markets, choose your preferred asset classes and instruments, and practice on a demo account to hone your trading strategy. Now, you’re ready to test your knowledge and skills on the live markets. Excellent. But does your trading strategy include risk management measures that will minimise losses and safeguard your profits? It is only natural to feel buoyant after a big win. The added confidence might tempt you to take on larger risks or deviate from your tried and tested strategy. But doing so could end in disaster. Here are some steps to include in your trading strategy to prevent profit erosion.

1. Avoid Overtrading and Under-trading

This is all about understanding your risk tolerance. Ambition is a good thing but being overambitious could lead you to risk your entire capital on a single trade. Experienced traders use the Pareto Principle, which states that “80% of the effects come from 20% of the causes.” In the world of trading, this translates to “80% of your profits will come from 20% of your trades.” Remember that the quality of your trades, patience and discipline are the keys to satisfying trading experiences, rather than quantity of trades. The rule of thumb is to not risk more than 1%-2% of the capital in your trading account on a single trade.

Under-trading, on the other hand, usually occurs due to a lack of confidence, fear of failure and “analysis paralysis” or failing to open a trade in time even after finding the right setups. However, remember that under-trading is different from avoiding setups that you might be uncomfortable with. If you find yourself overanalysing, it might be time to take a break and simplify your approach. Limit the number of indicators you use to only the most suitable ones. If you’re scared of losing money, choose a smaller position size and plan your exit with measures, such as stop-loss and take profit (discussed below).

2. Know When to Exit a Winning Trade

Exit strategies are as important as identifying the perfect entry. Stop-loss is an effective way to protect your trades if the market moves in an unfavourable direction. With a stop-loss order, you set the level at which your position will be automatically closed, minimising losses. Trailing-stop is a variation of this risk management technique, where the stop level changes according to the price moves, when the market is moving in a favourable direction. Similarly, take-profit orders involve a predetermined price level at which your position will be automatically closed to lock in profits before the market moves unfavourably.

Simply put, taking control of your losses is as important as focusing on profits while setting up trades.

3. Eliminate Emotions from Decision Making

Fear, greed and overconfidence are some emotions that can lead to irrational decision-making, derailing your trading strategy. The first step is to build and fine-tune a sound trading strategy, using your demo account to back-test it before applying it to the live markets. Now, regardless of market conditions, stick to your trading plan to prevent emotions from influencing trading decisions. 

Another effective way to keep emotions at bay is to automate trading. Robo-advisors and expert advisors (EAs), like those available on MT4 and MT5, are easy to set up, based on your trading strategy, risk tolerance and trading goals. You can also include risk management techniques, such as stop-loss and take profit, in the parametres you set for the EAs. Doing so also eliminates the need to constantly monitor the markets to find viable trading opportunities. The EAs track your chosen assets and automatically open and close positions based on the set parametres.

4. Understand Your Trading Psyche

Long-term survival in the financial markets depends on knowing your strengths and limitations. Understanding your trading behaviour, what situations make you feel stressed, and areas where you need to improve your skills and knowledge are crucial to enhancing your trading experiences. You can gain insights into your trading psyche by maintaining a trading journal. Use this to record each trade, what made you open and close a position, your feelings and thoughts, and successes and failures.

Go back to the trading journal regularly to gain clarity on what works best for you. This will help you identify the most suitable asset classes, trading timeframes (such as short-term strategies like scalping versus longer-term ones like position trading), indicators for technical analysis, etc. Use these insights to refine your strategy and set risk management measures. It is also important to know when to take a break from trading.

5. Simplify Your Approach

In the age of infobesity, the amount of market data and analytics tools available could be overwhelming. It is tempting to check out 10 different charts to confirm signals or look for market updates and expert opinions on multiple channels. The problem with using numerous charts is that they might give conflicting signals, adding to your confusion. The same is true when you seek the opinions of several experts.

Choose the experts you find the most helpful and limit yourself to only a few whose strategies match your own. Also, limit the use of indicators for each asset class, timeframe and market conditions.

Bonus Tip: Focus on the Long-Term and Diversify Your Portfolio

Spread your trades across uncorrelated and negatively correlated asset classes, sectors and even geographies. This way, the underperformance in one part of your portfolio will be mitigated by overperformance in other categories. Also, daily price moves are a reality of the financial markets. Even the best-known traders face their fair share of losses. Stay focused on your long-term trading goals since short-term market moves tend to get balanced out over time.

To Sum Up

• Long-term survival in the financial markets depends on how well you can limit losses and protect profits.
• Avoid over- and under-trading to safeguard your positions against losses.
• Determine your exit levels at the same time as you enter a trade.
• Automate trades to eliminate emotions from decision-making.
• Keep a trading journal to understand your trading psyche.
• Simplify your approach by choosing only a few suitable indicators for analysis.
• Diversify your portfolio.

Disclaimer

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