“Cut your losers and let your winners run.”
This is the oft quoted mantra of all expert traders and trading psychologists. It is easy to say but requires great discipline to actually do.
Discipline is the most important word in any trader’s dictionary. Great discipline is required in all aspects of running your trading business but never more so than when you are in a trade. A clear head and good discipline will mean you have no hesitation in cutting losing trades when they deviate from expectation or begin to move against you.
The Disposition Ratio is a great indicator of how disciplined your trading methodology is. It compares the average time spent in your winning trades to the average time spent in your losing trades. If your average winning trade is 48 hours in duration (time from first entry to final exit) and your average losing trade is 24 hours in duration then your Discipline Ratio is 2:1.
Most profitable traders achieve a disposition ratio of > 1. That is, they spend more time in winning trades than they do in trades that are going against them.
If you find that your disposition ratio is declining week on week or month on month, or is coming in below 1:1 then it is very likely an indication that you are taking profits too quickly or that you are losing discipline and letting trades run against you.
You can still be profitable with a ratio of 1 or less but you will need to be extremely talented at picking entry points as most big winners (the holy grail of trading) need time to develop and trades that are going against you often tend to keep going!