Friday, April 22, 2016

Reckless risk - and back to square one (again)

A while back, I talked about a long-time friend of mine and his battle against repeatedly losing all his hard earned gains in his own trading account (the original post is here).

I had not spoken to him for a couple of months, but he called me yesterday. Sadly, he had done it again. So what had he done this time?

Well, since January, he had slowly, and consistently, been making money risking a only a small proportion of his equity on each trade. And his account started to grow, along with his confidence. Then, after faithfully sticking to this plan for three months, he suddenly decided to increase his position size - by a factor of 10! You can guess what happened next…

While he trades in a completely different manner to me, he had developed a methodology with an edge which worked for him. But then he got over confident, dramatically increased his risk per trade, saw some losing trades, and started ‘revenge’ trading, losing all emotional control.

So three months hard work and discipline was wiped out by a couple of days pure indiscipline.

This is a clear example of how closely risk control and psychology are intertwined, and having those two elements firmly in place is key for all successful traders.

In Market Wizards, Ed Seykota talked about a fellow trader who continually went through a similar process:

"I know one trader who seems to get in near the start of every substantial move and works his $10,000 up to about a quarter of a million dollars. Then he changes his personality and loses it all back again. This process repeats like clockwork. Once I traded with him, but got out when his personality changed. I doubled my money while he wiped out as usual. I told him what I was doing, and even paid him a management fee. He just couldn't help himself."

So my friend is back to square one - again. One of these days, he might get it.

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