Do you panic and sell your stocks before they hit your stop loss?

This recently came up in a discussion with @TheChartKnight 

Long post. Bookmark to read it later 🔖 

It is easy to say "Follow your system", but it is probably the hardest thing to actually do in stock trading.

If you've created a trading system, conducted thorough backtesting and it yields a positive expectancy, you must follow it with discipline when you actually trade it.

Backtesting provides you with a roadmap, showing that your system will generate consistent results over time.

In fact, the only reason I trade my system is because I know for a fact that it works. Knowing it works and still not following it would be plain stupid on my part.

However, the actual effectiveness of a trading system depends entirely on your ability to execute it as designed. Sure, execution in real life cannot be as flawless as in your backtests, but the deviations should ideally be as minimal as humanly possible. Deviating from the system undermines its integrity and foundation, and the further you deviate, the more significant the difference in your profits will be compared to what they should have been.

For instance, if your system dictates specific entry, exit, and stop-loss criteria (AND IT MUST!), but you abandon these rules and engage in panic-selling during a 4% drawdown in a stock, you’ve effectively invalidated your strategy and rendered your backtests useless.

While this move might save you some money in the short term and make you feel smarter than your system, the bigger problem is that DISCRETION CANNOT BE BACKTESTED.

At that point, your carefully designed plan—along with all the backtesting data that supported it—becomes irrelevant. Such behaviour introduces randomness into your trading process, making outcomes unpredictable (and can eventually lead to feeling lost).

However, it does not stop there. Once you break away from your system, you're no longer following a structured, evidence-based approach. Instead, you're relying on discretionary decisions driven by emotions, such as fear or greed. This, more often than not, is a losing approach and a recipe for disaster. Experienced traders may still get away with making money when using discretion (because their discretion is based on experience), but new traders who already are not very profitable will likely end up in a deeper hole.

Without a tested methodology to guide these decisions, your trading becomes akin to gambling. In gambling, outcomes are dictated by chance, not by a strategic edge, and the same applies to discretionary trading without a solid, proven foundation.

Unfortunately, I cannot teach you discipline.

However, in my several years of trading experience, I have come to realize that backtesting is by far the best way to keep myself disciplined.

Once I know that my system has an edge, it makes perfect sense to execute it to perfection and leave discretion at the door. The backtest data is what reinforces discipline, and once you notice things working for you, these real trading results will further reinforce more discipline.

To succeed as a trader, consistency is key. A system with a positive expectancy works only if you trust it and execute it consistently without exception.

If you don't, it is no longer a system with a positive expectancy—it is only a backtest with a positive expectancy. And backtests don't make you money.