The Psychology of Holding onto BIG Gains
You might be asking yourself, “Why do I need to learn about the psychology of holding onto BIG Gains? It should be easy! There’s no challenge to trading when you’re holding onto big winners.”
There is a relationship to gains and losses. As you can imagine, there is also a relationship between BIG gains and BIG losses. You should, technically speaking, have zero emotional reaction to either. However, this is easier said than done (and ignoring your emotions doesn’t help in the long run).
It is true that a BIG loss is painful whereas a BIG gain is the best feeling in the world. There is generally a focus on how to handle yourself when you get BIG losses.
However, what if I told you that BIG gains are even MORE challenging to manage on a psychological level? And, on top of that, not managing them well could be a hidden reason preventing you from becoming a consistently profitable trader.
Don’t believe me? Hear me out:
What do you feel when you take a profit? I imagine you feel good, satisfied, calm. There was a lot of tension when you started the trade. Will it be a loser? Will I make money? How will things go? And when you finally sell for a profit, all that tension releases and you get to pat yourself on the back. You’re one step closer to achieving your dream.
What do you feel when you take a loss? I imagine you feel the opposite. It hurts, you feel bad, maybe you feel irritable. Another loss and you need to find a new trade idea. Oh, and if the market goes your way after you got out, you feel even worse. You have doubts, you’re wondering if you want to keep going. You’re one step back and it sucks.
What do you feel when you take a profit after seeing an unrealized loss on your position? I imagine that on top of feeling good, satisfied, calm, you were building a lot of tension when holding the unrealized loss. That tension built and built and built. You had doubts about yourself. Maybe your analysis was wrong. But with a stroke of luck, you can get out break even or even with a little profit. Wow, all that stomach churning and you’ve come out unscathed. You don’t quite feel like a big success but you live to trade another day.
What do you feel when you have a profit and then it goes into a loss? That’s a big emotional roller coaster! You start thinking that you should have taken profits when you saw them. You start wondering if things will go back to how they were before. You were right but now you’re wrong and things are starting to go against you. You’re not sure what to do next. You feel really dumb because you had the opportunity for success but you lost it out of ignorance or greed.
Do these scenarios sound familiar? Do they resonate with how you feel?
Do you know what the problem with all these scenarios are?
THEY HAVE NOTHING TO DO WITH WHAT IS HAPPENING IN THE MARKET!!!
The emotions you feel with respect to your positions are natural. You feel happy when they are going well, and you feel bad when they are going poorly.
However, when you make decisions based on emotions generated from your personal profit/loss, it’s a very self-oriented view on financial markets.
Your personal profit and loss are irrelevant to the market’s movements. Yet the emotions you feel are guiding your next move. That is wrong.
The Problem with BIG Profits
They cause our portfolio to become imbalanced
They cause us to become complacent
They might not be BIG enough
Portfolio Imbalance
Let’s say you have 10 positions in your portfolio with each position around 5-10% of your overall portfolio. If one position explodes 2x or 3x, that position will become 20%-30% of your overall portfolio
This is great in many respects because you’re up. However, it is horrible if that single position goes against you the other way later on.
You might be sitting pretty with a position that 2x-3x or even 10x. But you need to make a decision and there are only 3 available options:
Do nothing
Buy more
Sell some or all of the position
Do nothing
If a position becomes 10x its original value you’re happy, it’s amazing. And if you do nothing, it is the least emotionally stressful thing to do. It is literally just ignoring the situation and letting your winners run.
But isn’t that the problem? You’re ignoring the situation? Shouldn’t you be figuring out why your position 10x on you? And shouldn’t you correct the imbalance since it now constitutes a major portion of your portfolio?
Buy More
If you have a winner, have you ever considered buying more? It might sound preposterous to you but the most successful traders add to their winners. However, since the position became so outsized, wouldn’t buying more make things even more imbalanced?
On an emotional level, this is perplexing. You put your money in a position and it went your way. Adding more just means you’re risking more money, taking your moment of happiness and adding more tension to it.
Most traders don’t even think of buying more as an option but it is something that should be considered if we’re looking at all the actions we could take.
Sell some or all of it
This is the course most consider. You can sell some of it, take partial profits, let everything else ride. You can take all of it and pat yourself on the back. What could go wrong?
Well, the market could go even MORE in your favor and you missed out on even BIGGER profits.
You may console yourself and say, “Oh, I don’t want to be greedy.” But again, this way of thinking has nothing to do with the market. This is the biggest mistake of all. But give me some time. I’ll get into this a bit later.
Complacency
The true danger with having a BIG Gain in our portfolio is it makes us complacent. When we’re in a positive territory, we don’t think twice, we believe we got things right and we don’t focus on how to adjust our risk.
We generally focus on our losers and how to make them winners, trying to avoid the pain of a loss. We rarely try to figure out how to make our winners make us more money.
But let me ask you: Is it easier to turn a loser into a winner? Or is it easier to get a winner to win more?
From experience, I’ve found the latter to be true. I want you to reflect on that.
Is it easier to turn a loser into a winner or is it easier to get a winner to win more?
Is it easier for Facebook to get more market share or to get Myspace back on top as the main social medial platform?
Is it easier to overhaul Ford’s business model to start creating electric cars, or to bet on Tesla making more electric cars?
Is it easier turn around a failing construction business with poor management and leadership, or is it easier to ride the wave of a well-run construction business with good management and leadership?
How often do turnarounds happen? They happen, but do they happen more than winners winning more or losers losing more?
Your BIG Gain might not be BIG enough
Trading is all about balancing your losers and your winners. Therefore, there are two ways to lose the trading game:
You have too many losers that lose too much money
Your winners don’t make enough money to balance your losers
The big psychological trap is that most people focus on losers. They look at their losers trying to make them winners. They look at their losers, hold onto them as they lose more, trying to avoid psychological pain.
Having less losers is certainly important. However, in the process of reducing losers, people often take winners too soon. They want to feel the psychological release of tension when they have a BIG winner so they can feel they’re going the right way.
I used to do this. I took winners at 20% to 30% profit and kept losers till they lost 50%-100% of my position. I learned that when I held my winners for longer (and even added to positions), my winners became 100-300% profit while my losers stayed 20% losses. I had more losers, but my winners greatly made up for this.
The biggest problem is when you have a winner, you can’t learn these lessons because there is no pain. When you have a winner, there is no lesson because you think you did things well. You think you did well so you keep doing it. You keep taking 20% or 30% gain while leaving 100-300% gains on the table. But If you look back, you may find you took winners too soon and that hurts your overall performance (That’s what I did).
What should you do?
Managing BIG Gains is very challenging to do. Far more challenging than managing BIG losses. That’s because BIG losses are managed very easily. Take the loss and move on. BIG Gains, on the other hand, require a little more finesse. If you’re holding onto a BIG Winner, great! Congrats! Be happy. But let’s do things intelligently.
Firstly, you need to have a well-defined trading process. If you don’t, then you’re just asking for trouble. Check out these programs if you’re looking for a strong professional trading process.
If you have a well-defined trading process, it likely has very specific portfolio limits. You should follow these guidelines first and foremost.
Let’s use an example of a portfolio where you have 5 long ideas and 5 short ideas each of them no more than 10% of your total portfolio value and no less than 5% of your portfolio value. Also, they must all be in different industries to ensure a diversified portfolio.
Your Portfolio
5 Short ideas
5-10% of total portfolio value each
25-50% of Portfolio
5 Long ideas
5-10% of total portfolio value each
25-50% of Portfolio
Let’s say you have $1,000 in 10 positions for a portfolio of $10,000. Suddenly, one position goes to $11,000 so that your total portfolio is now worth $20,000 ($11,000 in one position, and then $1,000 in the other 9 positions).
Before
After
This clearly violates your mandate of 10% in one position. Therefore, among the 3 options you have, only one of them makes sense
Do nothing
Buy more
Sell some or all of the position
Now, you just need to decide whether to sell part of or all of the position. And in this very simplistic scenario, it’s obvious that you either sell the full $11,000 position or you sell $9,000 while keeping $2,000 in that winning position.
At this point, the second thing you need to do will be to look at the market. Sorry, I need to say this again.
LOOK AT THE MARKET!!!!!!
Once your portfolio is balanced, you need to ask yourself whether there is any reason you can imagine things would go against you. When stocks move BIG this way, volatility goes up, people are going crazy, algorithms are going nuts. It could reverse completely, it could continue even more. You need to ask yourself what you want to do about it.
Your decision needs to be based on fundamental analysis as well as technical analysis. It needs to be rooted in a strong professional trading process.
Notice how this method doesn’t really require you to have emotions in play at all. You just follow your portfolio guidelines and limits as well as your trading mandates. You follow the rules to avoid getting into trouble.
These rules are designed by you to prevent the worst of your psychology.
Caveat
The example above was just an example. I need to say this again:
JUST AN EXAMPLE.
I’m NOT saying sell your winners every time. Some situations require you to do nothing, buy, or sell.
Its
different every time.
The example I used deals with a 10x gain which is very extreme and very rare. I made it extreme to prove a point and make the decision very clear.
Every winner you have has a special set of circumstances. To work through those circumstances, it needs to be within your portfolio mandate, guidelines, and limits. After that, you need to look at the market to see what not do next. Sometimes it’s obvious with the 10x winner, sometimes it’ll be more nuanced with a 3x winner where you have losses in the rest of your portfolio. But the general process remains the same with a BIG Winner:
-
1
Follow your Portfolio Mandate/Guideline/Limits
-
2
Look at the market
Has nothing to do with emotions. Save that for your loved ones.
Your trading psychology might be the deciding factor for your next BIG win or your next BIG loss.
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