In this video we're going to look at a common bad habit that you can pick up on
when trading, and see what steps you can take to try and eliminate it. Hello I'm
David Jones from Capital.com and this is the latest in a series of videos
where we're looking at biases or common bad habits when trading. Our trading
platform at Capital.com has an algorithm that will try and detect if
you're slipping into bad habits, and push you towards articles and videos like
this, that hopefully help you identify it and try and eliminate it and take steps
to hopefully improve your trading. This time around we're going to look at the
disposition bias, so first of all let's see exactly what I mean by that, let's
explore this disposition effect in a bit more detail. So what do we actually mean
when we talk about disposition, it's this balance between our attitude to losing
trades and winning trades. So, put simply, holding losers too long. This is a really
common problem where someone has a trade on whatever market it is. The markets moving
against them and I think "well I'll just hang on a little bit longer because
maybe the market will come back and I'll start making a profit". So they build up a
bigger and bigger loss. The flip side of that is exiting profitable trades too
quickly. So coming out of a trade that's in profit and if the market just goes
back slightly panicking and snatching at that profit. So there may be a lot more
profit in the trade but they get shaken out by a slight move against them, so
they take their profits too quickly. And it's all about really spending too much
time in losing trades, so hoping the market is going to come back, maybe
rather than just taking your losses. Of course the flip side of that; not
giving profitable trades more time to work in your favour. If you've bought into
a market, and it's risen let's say for a couple of days, it's having the
confidence in your view to think "well actually there could be more profit to
come in this trade" and not having the fear that the
market is going to take that profit away from you. So why are these bad traits to
have? Let's have a look at the results of this approach. For many traders their
average winning trade is much less than their average losing trade. For example,
if when you're right when a trade is profitable you make £50 but when
you're wrong you lose £100, you can see that you need to be right
an awful lot of the time to make money. If you're right only 50-60%
of the time it's just not going to happen. So we really want to try and
shift that ratio between profit and loss the other way. Where our profits are
bigger than our losses. So as you saw there, put simply, it's our attitude to
profits and losses: taking profits too quickly,
letting losses run too far, staying too long and losing trades, and not staying
long enough in winning trades. That's the theory of it. Let's look at some real
examples and how this can play out in actual markets. I'm going to use an
extreme example here to illustrate the problem of getting shaken out of a trade
too quickly. Here's Netflix so the US stock [and] streaming video service. We
can see the prices hit a level of 205 / 204, has dollars has backed off and
it's come back, and it's broken out, so you might decide to buy at 205 because
you've got a breakout you think the price is going to move higher so you buy in
at 205. Let's walk forward a few days and see what happens next. So over the next
three days the price does move higher moves from 205 as high as 212 / 213, but
then we have this big down day, this down candle, and this spooks you because you
don't have a trading plan so you decide to snatch at your profits and you maybe
sell out at 210 you've made five dollars on the trade but you were hoping that
maybe there was more but a bit of weakness in the market has shaking you
out. What happens next? I said this was an extreme example and you can see that was
the point, you got shaken out around about 210 and the market just carried on
powering higher afterwards, in this example moving as high as 285. So this
is extreme but it does I think illustrate the
problem of snatching at profits too early if you don't have a plan. So when
we're in winning trades we want to try and give the trade to work time to work
out further in our favour. Let's think we're Netflix, we've jumped forwards
again in time, the price is trading now at $400 share. We decide to buy in
because we think the market is going to carry on higher. We could see there was a
low at 3.18 so we might decide to set our stop-loss let's say 372. If the
market drops 372 we're going to come out for a manageable loss but we're buying
in at 400. Let's just jump forwards and see what happens next we have a really
volatile couple of days, the next day the market actually gaps through our stop -
comes back up - we would have had the opportunity if we wanted to get our 372
but we think "well actually maybe this is just a strange move I'm going to hang, on my
stop was at 372 but I'm going to break my rules, I'm gonna wait and see if this
market does start to move higher". We jumped forward a couple of weeks. Now
we're really regretting [that] we didn't take that first loss. The price is trading at
337 so by breaking our rules, ignoring our stop-loss, staying in a losing trade
too long, we've incurred a much bigger loss than we were planning on taking and
plenty of people may even think I'll decide us to carry on holding and hope
it comes back, and the risk here of course if the losses just get bigger and
bigger. So this is a really common bias I think that plenty of us will experience
from time to time. Now we know what it is let's take a look at a way of combating
it. So let's look at some possible solutions, some things we can do to try
and eliminate this disposition. When we open a trade think about a profit target.
So if we're buyer at, let's say, 500 and we think the market could rally up to
550, don't be tempted to exit at 510, 515, 520. Try and squeeze as much out of the
trade as possible. Arguably, even more important, have a definite stop-loss
when you open a trade. If you're a buyer at 500 and you think the markets
going to go to 550 you may decide type your stop-loss at 485. So when you put
the trade on if the market starts going against you, don't be tempted to move
your stop-loss further away because you're going to stay longer in a losing
trade and you're going to increase your planned loss on the trade. Think
about the relationship between the risk (the potential loss) and your potential
profit. If you're doing trades where you're risking £50 to make £50
you may want to address that. What we want to do is have
our potential profit to be a multiple of our risk. So if we're looking
at a trade we want the potential upside to be maybe 2/3 maybe even more times
the size of our potential loss, and if that trade doesn't make sense from a
profit versus loss point of view we can pass on it and trade something else. So
it's all about giving more thought to the potential profit versus the actual
risk were willing to take and trying to squeeze out as much profit as possible
out of trades, and recognising losing trades, and exiting them for manageable
losses. I hope you found this video useful there'll be a whole load more
content that we'll be doing on this topic so to never miss out just make sure
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