Thursday, June 11, 2015

Losses, your mindset and risk

Most unsuccessful traders fall into the trap of assuming that the next trade will be a winning one. They can only see the potential profits – not the potential losses and the subsequent reduction in their equity.

To avoid this mindset, I recommend assuming that every trade you take will generate a full 1R loss. I do this, even though 99% of my losing trades end up being closed for a loss smaller than that.

This approach could help you avoid risking too much on an individual trade. Don’t think about the potential profits – always think about the potential losses. If you assume that your next trade will be a loser, will you want to suffer a huge dent in your equity? Keeping your risk per trade to 1 or 2% will help keep you in the game and avoid destroying your equity as a result of a small number of consecutive losing trades, which can happen to anyone.

”Always play great defense” – Paul Tudor Jones

Very occasionally, you could suffer from slippage, or a price gap against you, and may well result in you suffering a loss greater than 1R. Or, price may start to move against you, but rather than take a small loss, you hold on in the hope that price will move back in your favour. And a small loss could start to develop into a much bigger loss. If that happens, you could lose a sizable chunk of your equity overnight. How would you feel about that? Who would you blame for the loss? Perhaps more importantly, who should you blame?

Over the last three years, I have had four trades close for a loss greater than -1R. All of these occurred as a result of price gaps related to earnings, and in all these cases, I was sitting in profit prior to the announcements. Hence why I avoid initiating new trades when I know earnings reports are imminent.

Remember that, as a trader, you are 100% in control of your actions. These include determining your position size and risk per trade levels. So, if a trade goes wrong, and you end up suffering a big loss, who is to blame - the market, your broker, your trading platform, or yourself?

Taking responsibility for your own actions, and accepting the results of those actions are critical to your development as a trader.

You can only control the elements you can control, and you cannot control the markets and where price goes. You have to let the market do its thing, and if price goes against you, then you have to accept that the market is telling you that you are wrong, take the loss and move on.

A lot of struggling traders seem to comfort themselves by saying that a paper loss is not a real loss. If they are not careful, they end up riding that loss. The worst case scenario is that a trade will end up turning into a long-term (losing) investment.

I remember an individual some years back giving me grief on a bulletin board for taking a small loss on a trade. He later let slip in a different conversation with another trader that he had been holding a losing position on a stock for nine YEARS! In that time the stock price had dropped in value from several pounds per share to a few pennies.

Remember that your best loss is always your smallest loss. Don’t let the fact you want to be proven right on a trade or stock get in the way of your principal objective – to make money over the long-term. Keeping any losses as small as possible is a major part of achieving that goal.

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