Wanted to share an article I most recently wrote - hope it finds you well!
[U]Embracing Risk[/U]
[I]How to Increase Your Profits by Managing Your Losses[/I].
Losing is a part of trading. Let me repeat that. Losing is a part of trading.
To most novices, there is a direct connection/relationship between the health of their trading account’s equity curve and the overall happiness level they exhibit away from trading in normal, everyday life. When you’re consistently extracting capital from the market everything “on the outside” seems peachy. All cylinders are firing, your bearings are set and your trading trajectory is calm and nothing but smooth sailing. A couple of losses here and there can easily be negated with a few multiple-R trades, but, every now and then the novice trader digs themselves into a hole.
[B]How So?[/B]
Call it over-confidence, greed, aggression, whatever name you want to give “it” – the outcome is always the same. Stress, frustration, anger, sadness – a plethora of emotions build up, and the only way to calm the madness is to make one more trade and use a little more leverage which can at least win back some of the 15% of your equity which just evaporated.
Unfortunately, too many times have I read about one or two small mistakes which started out costing 5-6% of a trader’s equity, which then snowballs into 15 and maybe even 20% lost by the end of the day. Why does this happen? How can you be consistent and disciplined for 3 weeks straight, and wipe out all of that hard work in a single session?
[B]Reality Sets In[/B]
No trader in the history of trading has ever “won” every single trade he/she has placed over their career. And this is something which is hard for the human mind to manage. When a stop is triggered, the first thing the brain will conjure up is, “Oh no, I did something wrong”. In essence, yes, you may have. You may have bought into a situation which called for shorts. Lesson learned and hopefully you move on. But, the stop being triggered and the equity draining from your account has an oddly profound impact on the novice trader. An impact in which if it occurs multiple subsequent times, can stir up what I call a frenzy.
It’s within this “frenzy” state, where bad analysis is used, trading plans are tossed aside, rash decisions are made, and the individual tries to chase the market and subconsciously take revenge for the damage done. This is where the compounding effect occurs – where one or two small losses snowball into some serious equity damage, leaving the trader feeling abused, confused, and regretful.
[B]The Damage is Done- Now What?[/B]
Do you throw in the towel? Do you bash your hand on your desk? Do you toss this system out the window which had been returning profits for 3 weeks consistently for something new? Is it the system? Is it me? Was it just a fluke? Was I just getting lucky those 3 weeks? The questions go on and on as you try to define, justify, and make sense of what just happened as you stare at your screen wondering why.
But, the most important question is never asked. In the grand scheme of things, is this minor deviation / setback the end of my trading career? If you blew your account, maybe in the near term it is the end of live trading. If you have some equity left, well, then you’re still in business…
Think about it: If you deviate one day, and your account takes a hit - 10, 15, maybe even 20% in a few hours off some “loose” trading. If you are truly determined to become a professional trader, which is what you will need to be if you ever want to trade for a living, then consider this: You have the rest of your life on Earth to make that money back. Sounds stupid, but its right and should be inspiring.
Think about it. It’s not the end of the world. Yes, your equity curve may take a dip, your risk of ruin tables may look a bit ugly for some time, and your drawdown will be jacked. But, at the end of the day, if you are completely devoted and serious about trading, then you need to draw from this experience and seek to never repeat it.
You dug yourself into a hole, and now you need to climb out, one step at a time. You can’t simply bend your knees and launch back up onto solid ground with one giant leap. You need to grab the walls, dig your hands, fingernails, and feet in, and climb inch by inch, foot by foot. When you do that, and make it to the top of that “hole”, you can then look back down and evaluate the journey; pledging to yourself to never get back down in there again.
It will take a toll on you mentally. It will take a toll on you financially. But, the sooner you can train your psyche to deal with seeing your account experience some periods of losses, the better you will be in the long run. Losing is just as much a part of trading as winning is. I don’t particularly like to use those two terms, but, they illustrate my point.
[B]How to Right the Course:[/B]
[ul]
[li]Embrace your losses. Learn from them. Treat your losses as you do your wins. How many traders do you know whom keep a trading journal? Of them, how many keep screenshots and some notes about their winning trades? Of THEM, how many keep screenshots and some notes about their LOSING trades? No need to go crazy, but, a win and a loss should have the same emotional impact on you as a trader. Wins can’t come without losses, and losses can’t come without wins. It’s how you manage that loss which is essential (to be discussed later).
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[li]Just as you place a limit based on an expectation as to where price may “go” by reading a chart, stop losses need to be placed in areas where you reasonably expect price not to go. If it goes there, then you most likely were wrong in your estimation, and need to exit the trade. Moving your stop or adding to a losing position are two pitfalls which can further compound a loss. Accept you were wrong and move on.
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[li]Manage your risk and do not over-leverage yourself- This is the most important aspect of them all. If your trading plan calls for 2% equity risked / trade, and you see that there are potential setups across 3 or 4 different pairs, why not split your equity out and risk .05% / position instead? Also, try to cap your daily / weekly losses. Are the profits from your winning trades outweighing your losing ones? Try to consistently target trade setups which return 2:1 - (for every $1 risked from the onset, $2 can be gained).
[/li]
[li]Strive to not let your emotions analyze the market. Charts need to be read with the brain, not the heart. After taking a few losses, there is nothing wrong with walking away, shutting down, and unplugging from the markets for a session or two (or longer). Sometimes simply walking away can reset you mentally and provide a refreshing mindset to re-tackle the markets. You will not miss any setup. Hedge fund managers aren’t paid to make “the trade of the year” off a single-position. Trading is about slowly building your equity by managing your risk.
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[B]Recap[/B]
Yes, all of this is easier said than done. But, I’m sick of that adage. Everything is easier said than done in life. You can only build character by actually going out there and doing “it”. Whatever “it” is – finishing school, writing a book, learning a martial art, or trading currencies – all take time.
Trading currencies is not gambling. If you want to gamble, go to a casino, walk in, and head directly to the roulette table. You can play a 50/50 shot on red or black. You want to double your equity so you can quit your job that quickly? - then trading is not the proper way to reach that goal. Building capital takes time and discipline.
Discipline not only to trade with a professional mindset, but also to follow a trading plan which lays the groundwork for all of your decision making. If you’re not managing your risk, then your risk will manage you.
If you have any questions / comments - please feel free to let me know!
