Saturday, July 11, 2015

Dale Carnegie and thinking about losses

These days I am a voracious reader, not so much of books directly related to trading, but to those dealing with the mind, attitudes or psychology. 

Interviews with, or autobiographies of top sportsmen or women are a good resource as well. When reading these, my mind automatically thinks about whatever is being discussed, and whether it can be applied to trading, and my own approach in particular. In that regard, I am always open to new or different ways of thinking.

It may be whole chapter, it may be a single sentence - it doesn't matter. If it helps me, I will take it, think about it more and see if it can be incorporated either into my way of trading or thinking. Just as importantly, it can also help me communicate better with other traders when it comes to dealing with certain issues.

This process has become ingrained in me - I cannot stop it, even if I wanted to. I never know when I will come across something that could help me improve my performance.

One such book I is 'How to Stop Worrying and Start Living' by Dale Carnegie, which a girl friend of mine had recently read and enabled her to overcome an issue which she had struggled with for a number of years. 

Originally published more than 60 years ago, I found there are plenty of stories and anecdotes in there which can easily be transferred into the trading arena - and consequently, may be able to help you.

One such chapter talks about a Willis H. Carrier, and his own 'Magic Formula for solving Worry Situations'. This was basically summarised in three steps as follows:
  • Analyse the situation as fearlessly and honestly and figure out what is the worst that could possibly happen as a result of this failure.;
  • After figuring out what was the worst that could possibly happen, reconcile yourself to accepting it;
  • From that time on, calmly devoted your time and energy to trying to improve upon the worst which you have already accepted mentally.
So, as an example, how can this be applied to trading?

Firstly, I've often have talked in the past of being able to accept that every trade I take will be a loser - I automatically assume that I will lose -1R every time I open a new position.

Other than when there is a price gap to deal with, I have fully quantified the worst case scenario for each trade. Too many inexperienced or unsuccessful traders only focus on the potential winnings from a trade - not the consequences of the trade generating a loss. Just this thought alone can help you avoid taking big risks relative to your equity on each trade.

Secondly, you need to mentally accept that you will lose this money from your account. This enables you to keep your emotions and stress levels under control, which gives you freedom to think clearly and as objectively as possible. Van Tharp talks about accepting responsibility for your actions, which is a similar theme. You've placed the trade, you quantified the position size and risk, therefore you need to accept that you may lose that money.

Thirdly, while I accept I may lose -1R on a trade (or maybe even more if price gaps against me), my trading approach is geared towards cutting losses as quickly as possible. I therefore always try and improve on the outcome I have already mentally accepted.

The vast majority of my losing trades equate to less than half of the full 1R loss I have accounted for (and been prepared to risk) on each trade. This is because I have attempted to factor in some element of slippage into my risk calculations, and as a result it allows me to have a complete 'emotional indifference' towards losses. My rules dictate when a setup I have taken has not worked, and enable me to dispassionately close the trade and move on.

Of course, there can be instances where the loss can end up being greater than that anticipated - primarily as a result of a price gap against me. Over the last three years, the biggest loss I have suffered from a price gap (which was tied to the release of an earnings report) is less than 2R. Given the returns I have been able to generate, I am 100% comfortable with my risk approach.

The above is just one example of where reading something relating to a completely different situation can be applied to trading. Always keep your eyes (and mind!) open to new ideas or ways of thinking - they may help you improve your own trading mindset and ultimately your performance.

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