The most important element of successful trading is the ability to manage risk and maintain composure. Even the best traders in the world lose on a regular basis. Success in trading therefore is not about avoiding losses. In contrast, we must embrace the process of losing and learn to lose gracefully. The best traders are also the best losers. We learn that losing is simply a part of trading that can’t be avoided or ignored. My friend Ross Cameron at Warrior Trading works extensively with new traders to help teach them the skills to maintain composure in stressful situations. In my experience these skills are what ultimately separate the successful traders from those destined for failure.
Fighting Natural Instincts
In many ways trading is a game of numbers. The numbers are bleak as 9 out of 10 trades are expected to fail as traders. In fact, only about 1% of the investors that attempt to day trade will come away consistently profitable. With such dismal statistics let’s take a look at one of the biggest stumbling blocks for new traders: recovering from a loss. Losing is part of trading. We know the best traders take big losses from time to time. Remember Bill Ackman and his Herbalife Short or JCPenny’s Long? This leaves a huge number of losses each year and yet they still seem to come out on top. The key to finding success despite losing trades is to learn to manage your losses. This means fighting against your natural instincts. When I was a new trader I would often take a losing trade in the morning and then come back mid-morning with an extremely large position to try to make back the previous loss. This is the worst thing you can do. The urge to try to get back a loss causes emotional trading. Emotional trading is a form of gambling.
The Snow Ball Effect
The common sequence of events for me was to take a trade in the morning. If that trade was a winner and I made my $500/daily goal I would throw in the towel and go hit the beach. I would go weeks at a time with back to back green days and tens of thousands in profit. But eventually there would be a day I would take a loss out of the gates. If I took a $500 loss, I would continue trading instead of walking away. This should be known as mistake #1. On the 2nd trade I would take double the position size of the first trade. This was because I needed a double size winner to first get me out of the hole of the initial loss and then second to get me up to the daily goal.
The problem with the strategy of doubling up on my rebound trade is that more often than not it would result in a second loss. Unfortunately the second loss would be $1000, or twice as big as the first loss, and now I would be deep in the red and 4 times away from my daily goal. This is where the emotions begin to really take hold. The only hope is a desperate attempt to get a winning trade that is 4x the daily goal. That is hoping and praying or a homerun after a series of failures. Instead of walking away down $1500 I would take a monster position on a third trade. Occasionally I would get lucky and get out of the whole and up to my daily goal. I want to emphasis the word LUCKY. My emotions were allowing me to gamble with my trading account. The only thing I could hope for was luck.
If luck wasn’t on my side I’d end the day down big time. My hot streak of 4-6 weeks would come to a crashing end. By the time I had lost on my 3rd trade or even 4th trade in the Snow Ball sequence, I would be down anywhere from 5k-8k in a single day. That Snow Ball Effect is something I experienced more times than I can count. Over a period of 12 months it cost me tens of thousands of dollars in losses. It’s also something many other traders have spoken with me about. I realized it was actually a common experience for beginner traders. We allow our emotions to take control.
The worst part about the Snow Ball Effect was that it typically resulted in giving back almost the entire profit from a hot streak. I would experience a blowout day once every 4-6 weeks and give back all the profits I’d gained in that time. I would take 4-6 weeks to generate 5-10k in profits and give it all back in the period of 6 hours of emotional trading. After reviewing my trading account and realizing this pattern was repeating itself I knew I needed an intervention!
Take Your Loss As An Opportunity To Learn
Over a period of 18 months I was down over 60k in trading losses. It was a massive hole to dig myself out of. I’ll admit there was still the gambling trader in me that would think about putting my entire account balance on an options trade and hope for a 100k winner that would make up for all those losses and then some. I had to fight every single day to keep my emotions in check. I realized if I could simply learn to walk away down -$250 after the first loss it could be the difference between being profitable versus failing. It was that day that I made a commitment. It was a simple idea. Set a max loss on the day and walk away when it gets hit. The hard part would be holding myself to this rule.
One Trade At A Time
I changed my entire school of thought. I accepted the hole I had dug for myself as my new reality. I reminded myself that you can’t build a home in a day. You build one brick at a time. Sometimes there will be a mistake and part of a wall might fall down. You can’t rebuild that wall by throwing the bricks at it. You have to start back with one brick at a time. I changed my mind set to the big picture. Most importantly, I let go of the desire to make it all back in one trade. I realized over the course of the next 5 years if I had 1000 trades that were $1000 winners that would be $1mil in trading profits. I set that as my new goal and I’m still working towards that today.
You are probably wondering if I was able to hold myself to the max loss rule. I set a max loss of -$250. If I hit the max loss I closed down my broker platform and turned off my computer. I would then unplug my computer and tape a sheet to the monitor reminding myself of the bigger picture. My biggest problem during my early years trading was impulsive gambling. I was able to remove the ability to be impulsive by turning off my computer. It required too much work to get back online to be impulsive. This did the trick. One trade at a time I made back the $60k I lost and started generating enough profits to make a living as a trader. The only way to recover from my massive losses was to focus on one brick at a time, one trade at a time.
Author Bio – This article was written by Joshua Rodriguez, owner and founder of CNA Finance!
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