You gotta know when to hold 'em, know when to fold 'em, know when to walk away, know when to run.
In addition to knowing when to buy and when to sell it's equally important to know when to stay out of the markets and in cash. When market conditions aren't conducive to profitable tradition, just stand aside. Even seasoned professionals frequently step back and reevaluate their methods. Old market cliche' when in doubt, stay out! Do not be afraid to acknowledge your limitations, do not force trades, take a rest, and enter the markets when you're ready. There are many practical reasons for standing aside.
You may feel tired, down, or just not feeling at your best. At times like these it is best to stand aside until you are rested and can return to the positive objective mindset you need for trading. If your psychological resources are depleted you may act emotionally and or impulsively. If you are tempted to trade when your psychological resources are depleted you risk putting on bad trade after bad trade, not only will your account balance be hit so will your ego.
Another good reason to stay out of the markets is when your method seems to cease to have its winning edge. No trading method works indefinitely. When market conditions change, even a "foolproof" method can stop working. Don't make this situation even worse by continuing to trade. When a method stops working, it can really stop working. Your account balance will decline with each trade.
Most professionals often say that they are at their best when their old method starts to falter and they have to devise a new one. They view the situation as a puzzle they must solve. They step away from the markets, and take a close look at their methods. They try to identify what went wrong with the method, and look forward to tweaking it until it works again. They search for market factors that may have changed, and when they think they have found the solution, they put on a few small trades to test out their new, revised method. So when your method stops working, don't continue trading at the same level of activity. Step back, look things over, and wait until conditions are just right before entering.
Trading profitably requires that you keep track of the market moods and your psychological moods. When either one is not conducive to trading, it's best to stand aside and wait for the situation to change. By staying out of the markets, you can survive to trade another day, when you're in a peak performance mental state and the market conditions are optimal.
Reprint from Prudent Trader Archives 2005