This post attempts to provide some open-ended insight into the way in which different mindsets toward P/L could potentially impact on a trader’s decision making. My comments are intended to be general in nature, and not specifically related to any particular trading strategy. IMO it's helpful to examine the reasons for why we think the way that we do, if it can help us to improve our trading psychology.
Let’s suppose I’m +30 pips in a buy trade and (for better or worse) I move my SL up to breakeven.
(#1) Conventional thinking tells me: “Hooray! I can relax, I’m in a free trade. I can’t lose now”.
(#2) Just for the sake of argument, here’s a different way of looking at it. I can still potentially lose the 30 pips that I’ve just made. Hence those 30 pips aren’t really ‘safe’ until I bank them.
To further demonstrate this, suppose (hypothetically) I was to close the trade, and open a new one of identical size, and likewise with a SL 30 pips away. Apart from the additional br0ker cost, my total equity, my exposure to risk, and my consumed margin, all remain completely unchanged. But despite this mathematical reality, if I get stopped out, I’ll have a trade that will show as a l-o-s-s in my books, and I can feel the blood pressure starting to rise again!
But hold the phone — that’s not necessarily true if I mentally group this trade with the last one. I can ‘afford’ to lose 30 pips, because I just won 30 pips..... which of course brings us back to the original ‘free trade’ mindset (#1). Things are apparently not so bad after all!
But if I’m allowed to mentally (and arbitrarily) group trades together, why can’t I ‘afford’ to lose 30 pips because I made a 30 pip winning trade several weeks ago? Or why can’t I afford lose 200 pips because I made 200 pips back in April, or lose 1,500 pips because I’m currently 1,500 pips up for the year? What makes the most recent trade seem like the most important one, when (everything else being equal) the pips (or dollars) won/lost on one trade are no more or less significant than the pips (or dollars) won/lost on any other trade? Answer: the illusion of “recency bias” (which also provides the motivation for rescue/recovery trading). Recency bias is a symptom of mindset #1.
So, to summarize, here is the fundamental difference between the two mindsets:
Mindset #1 is the 'textbook' thinking that most traders seem to adopt. It takes the view that the 30 pips are not at risk, because the SL is at BE and we're in a free trade. I've gained 30 pips, hence I can ‘afford’ to lose them.
Mindset #2 takes this opposite view: those hard-earned 30 pips are every bit as valuable as any other 30 pips, and are at risk unless/until I bank them by closing the trade. If I lose those 30 pips, my eventual bottom line will be 30 pips worse off than it otherwise would have been.
(#3) Now, just to confuse things even further, here’s a third way of looking at the same reality: I’m currently +30 with the SL at BE.
Suppose I choose to take the view that, at any current point, I have an approx 50/50 probability that price will rise or fall henceforth. In other words, my 30 pip profit will continue to increase (hence keeping the position open is a good decision) around 50% of the time, and it will decrease (hence closing the position would be a good decision) around 50% of the time. Over a large number of trades, then, this will tend to be self-balancing, and hence it really doesn’t matter, mathematically, whether I close the trade or not. If I take this view, then, my 30 pips is effectively as good as banked, and closing the trade becomes little more than a comfort measure.
Now, to summarize, here is the fundamental difference between mindsets #2 and #3:
Mindset #2 takes the view that (floating) losses are inconsequential until the trade is closed and the profit (or loss) is realized. While unrealized, the 30 pips are at risk; when the trade is closed, the 30 pips are safely banked.
Mindset #3 sees no difference between floating and realized losses. Again, if I use the example of closing and then re-opening an identical position, I’ve realized my P/L, but (apart from the broker costs) my total equity, my exposure to risk, and my consumed margin, all remain completely unchanged. If we choose to adopt this view, all profits and losses are tangible irrespective of whether they've been realized or not.
(#4) There are probably other potential mindsets that I haven’t thought of.
I don’t think it’s possible to categorically prove that one mindset is any more valid than the others. (Just as it’s impossible to prove whether it’s better to think of P/L in terms of pips, dollars, or percent equity — all have their pros and cons — a worthy topic for another post?). One mindset may be psychologically more palatable, or otherwise possibly more healthy, than the others, but it ultimately comes down to personal preference.
However, in exercising my own preference, I definitely favor mindset #3. If we extrapolate the ideas in #3, they can lead us to the realization that what has happened in the past — closed trades, or even everything that’s happened to date in currently open trades — can’t be changed, and is therefore irrelevant to any subsequent decision-making. The market takes no cognizance of my P/L, so whether I’m currently +30 or –30 is immaterial — any decisions should logically be based on whether price is likely rise or fall henceforth — and if I have no objective statistical reasons to substantiate a decision, then whether I close or not really makes no difference.
Moreover, #3 makes initial risk/reward calculations seem meaningless, because risk and reward are always changing dynamically as the trade unfolds.
As I’ve attempted to argue in all of the same-pair-hedging/martingale/MM threads, success is ultimately about being net long while price is rising, and net short while it’s falling, heavily/frequently enough to overcome costs. The more accurately the trader adjusts his net position relative to turns in the market, the more pips he’ll bank. Everything else is ultimately smoke and mirrors, a figment of the trader’s P/L-fixated imagination. These conclusions are possible if we choose to adopt mindset #3.
Some other considerations imposed by the different mindsets:
Mindset #1 can justify the pyramiding of orders: if I’ve safely locked in profit on a trade, I can afford to risk that profit by opening another trade, pyramiding (averaging up) into what is hopefully an emerging trend. Whereas mindsets #2 and #3 both tell me that (everything else being equal) all orders contribute equally to bottom line, and if the subsequent positions lack objective statistical backing — or worse, are a statistically losing proposition in their own right — then overall, I’d be better off without them, regardless of whether they’re being ‘funded’ by prior wins or not.
A final summary, just in case the above was unclear:
Mindset #1: the trader is predominantly focused on the performance of individual trades, and his approach is motivated by things like initial risk/reward, and possibly even rescue/recovery through the arbitrary mental grouping of his most recent trades. Pips (or dollars) gained in current or recent trades are seen as being expendable and can be used as ‘risk capital’ in new trades. (I don't want to get into the same-pair hedging argument, but those who see same-pair hedging as a strategy in itself would likely fall into this group, also).
Mindset #2 represents a different ‘level’: the trader is freed somewhat from viewing each trade as an individual entity, and becomes more focused on on pips (or dollars) gained overall. He sees each pip (or dollar), recent or historical, as being equally valuable. In his view, pips are not safe until trades are closed, hence he seeks to realize gains as early as he sees as being sensible.
Mindset #3: the trader is no longer focused on P/L: whether P/L is floating or realized is irrelevant. All that matters to him is whether price is henceforth more likely to rise or fall, and whether he is correctly aligned (long or short) to exploit this. (Of course how successfully he achieves this depends on his knowledge/skill in determining probable directional or behavioral bias). Trading becomes a dynamic, fluid process, and all decisions are based solely on market behavior and current probabilities.
Of course it's possible that a trader's view includes some aspects of one mindset, and some of another.
Finally, here’s another conundrum to ponder: the textbooks tell us that it’s better to stay out of the market, if we’re uncertain, than to risk making a loss.
Well, if I make a 30 pip loss, my eventual bottom line will be 30 pips worse off than it otherwise would have been.
But if I miss out on a 30 pip win, my eventual bottom line will likewise be 30 pips worse off than it otherwise would have been.
Again, it’s just another way of looking at it. And perhaps just a silly one, in keeping with the thread title.
Let’s suppose I’m +30 pips in a buy trade and (for better or worse) I move my SL up to breakeven.
(#1) Conventional thinking tells me: “Hooray! I can relax, I’m in a free trade. I can’t lose now”.
(#2) Just for the sake of argument, here’s a different way of looking at it. I can still potentially lose the 30 pips that I’ve just made. Hence those 30 pips aren’t really ‘safe’ until I bank them.
To further demonstrate this, suppose (hypothetically) I was to close the trade, and open a new one of identical size, and likewise with a SL 30 pips away. Apart from the additional br0ker cost, my total equity, my exposure to risk, and my consumed margin, all remain completely unchanged. But despite this mathematical reality, if I get stopped out, I’ll have a trade that will show as a l-o-s-s in my books, and I can feel the blood pressure starting to rise again!
But hold the phone — that’s not necessarily true if I mentally group this trade with the last one. I can ‘afford’ to lose 30 pips, because I just won 30 pips..... which of course brings us back to the original ‘free trade’ mindset (#1). Things are apparently not so bad after all!
But if I’m allowed to mentally (and arbitrarily) group trades together, why can’t I ‘afford’ to lose 30 pips because I made a 30 pip winning trade several weeks ago? Or why can’t I afford lose 200 pips because I made 200 pips back in April, or lose 1,500 pips because I’m currently 1,500 pips up for the year? What makes the most recent trade seem like the most important one, when (everything else being equal) the pips (or dollars) won/lost on one trade are no more or less significant than the pips (or dollars) won/lost on any other trade? Answer: the illusion of “recency bias” (which also provides the motivation for rescue/recovery trading). Recency bias is a symptom of mindset #1.
So, to summarize, here is the fundamental difference between the two mindsets:
Mindset #1 is the 'textbook' thinking that most traders seem to adopt. It takes the view that the 30 pips are not at risk, because the SL is at BE and we're in a free trade. I've gained 30 pips, hence I can ‘afford’ to lose them.
Mindset #2 takes this opposite view: those hard-earned 30 pips are every bit as valuable as any other 30 pips, and are at risk unless/until I bank them by closing the trade. If I lose those 30 pips, my eventual bottom line will be 30 pips worse off than it otherwise would have been.
(#3) Now, just to confuse things even further, here’s a third way of looking at the same reality: I’m currently +30 with the SL at BE.
Suppose I choose to take the view that, at any current point, I have an approx 50/50 probability that price will rise or fall henceforth. In other words, my 30 pip profit will continue to increase (hence keeping the position open is a good decision) around 50% of the time, and it will decrease (hence closing the position would be a good decision) around 50% of the time. Over a large number of trades, then, this will tend to be self-balancing, and hence it really doesn’t matter, mathematically, whether I close the trade or not. If I take this view, then, my 30 pips is effectively as good as banked, and closing the trade becomes little more than a comfort measure.
Now, to summarize, here is the fundamental difference between mindsets #2 and #3:
Mindset #2 takes the view that (floating) losses are inconsequential until the trade is closed and the profit (or loss) is realized. While unrealized, the 30 pips are at risk; when the trade is closed, the 30 pips are safely banked.
Mindset #3 sees no difference between floating and realized losses. Again, if I use the example of closing and then re-opening an identical position, I’ve realized my P/L, but (apart from the broker costs) my total equity, my exposure to risk, and my consumed margin, all remain completely unchanged. If we choose to adopt this view, all profits and losses are tangible irrespective of whether they've been realized or not.
(#4) There are probably other potential mindsets that I haven’t thought of.
I don’t think it’s possible to categorically prove that one mindset is any more valid than the others. (Just as it’s impossible to prove whether it’s better to think of P/L in terms of pips, dollars, or percent equity — all have their pros and cons — a worthy topic for another post?). One mindset may be psychologically more palatable, or otherwise possibly more healthy, than the others, but it ultimately comes down to personal preference.
However, in exercising my own preference, I definitely favor mindset #3. If we extrapolate the ideas in #3, they can lead us to the realization that what has happened in the past — closed trades, or even everything that’s happened to date in currently open trades — can’t be changed, and is therefore irrelevant to any subsequent decision-making. The market takes no cognizance of my P/L, so whether I’m currently +30 or –30 is immaterial — any decisions should logically be based on whether price is likely rise or fall henceforth — and if I have no objective statistical reasons to substantiate a decision, then whether I close or not really makes no difference.
Moreover, #3 makes initial risk/reward calculations seem meaningless, because risk and reward are always changing dynamically as the trade unfolds.
As I’ve attempted to argue in all of the same-pair-hedging/martingale/MM threads, success is ultimately about being net long while price is rising, and net short while it’s falling, heavily/frequently enough to overcome costs. The more accurately the trader adjusts his net position relative to turns in the market, the more pips he’ll bank. Everything else is ultimately smoke and mirrors, a figment of the trader’s P/L-fixated imagination. These conclusions are possible if we choose to adopt mindset #3.
Some other considerations imposed by the different mindsets:
Mindset #1 can justify the pyramiding of orders: if I’ve safely locked in profit on a trade, I can afford to risk that profit by opening another trade, pyramiding (averaging up) into what is hopefully an emerging trend. Whereas mindsets #2 and #3 both tell me that (everything else being equal) all orders contribute equally to bottom line, and if the subsequent positions lack objective statistical backing — or worse, are a statistically losing proposition in their own right — then overall, I’d be better off without them, regardless of whether they’re being ‘funded’ by prior wins or not.
A final summary, just in case the above was unclear:
Mindset #1: the trader is predominantly focused on the performance of individual trades, and his approach is motivated by things like initial risk/reward, and possibly even rescue/recovery through the arbitrary mental grouping of his most recent trades. Pips (or dollars) gained in current or recent trades are seen as being expendable and can be used as ‘risk capital’ in new trades. (I don't want to get into the same-pair hedging argument, but those who see same-pair hedging as a strategy in itself would likely fall into this group, also).
Mindset #2 represents a different ‘level’: the trader is freed somewhat from viewing each trade as an individual entity, and becomes more focused on on pips (or dollars) gained overall. He sees each pip (or dollar), recent or historical, as being equally valuable. In his view, pips are not safe until trades are closed, hence he seeks to realize gains as early as he sees as being sensible.
Mindset #3: the trader is no longer focused on P/L: whether P/L is floating or realized is irrelevant. All that matters to him is whether price is henceforth more likely to rise or fall, and whether he is correctly aligned (long or short) to exploit this. (Of course how successfully he achieves this depends on his knowledge/skill in determining probable directional or behavioral bias). Trading becomes a dynamic, fluid process, and all decisions are based solely on market behavior and current probabilities.
Of course it's possible that a trader's view includes some aspects of one mindset, and some of another.
Finally, here’s another conundrum to ponder: the textbooks tell us that it’s better to stay out of the market, if we’re uncertain, than to risk making a loss.
Well, if I make a 30 pip loss, my eventual bottom line will be 30 pips worse off than it otherwise would have been.
But if I miss out on a 30 pip win, my eventual bottom line will likewise be 30 pips worse off than it otherwise would have been.
Again, it’s just another way of looking at it. And perhaps just a silly one, in keeping with the thread title.