Taking losses and Dealing with Disaster

Taking losses and Dealing with Disaster

On December 2nd, 2009, we held an impromptu webinar over GoToWebinar where 203 attendees heard a discussion about what is probably the most important topic in trading psychology: The ability to take losses. The conversation was triggered by an email I got from a follower who lost $15,000 (I thought it was just 15 ES points) trading on Monday.

This person has a trading plan, uses stops, defines and accepts his risk of his trades and believes that he is generally disciplined. He has been in this business 15 years and has a rough time over the last 3 months. Does this sound familiar? It does to me.

I read our email correspondence in TinyChat before we were forced to move to GTW for technical reasons, but it seems like he had it all together and this was just a bad day. However, trading is much like sports competition or battle in that the outcome is as good as the weakest link in the system.

Firstly, this person did not have a daily loss limit. I have discussed daily loss limits before. I have one on my account and it is based on my 20-day average daily net profit. It is the safety valve that gets tripped when things are really getting out of control. It is a lifesaver and I have regretted adjusting it during the day 9 out of 10 times. Adjusting it usually leads me to run up more roundturns with no benefit or, worse, I lose more money. I just don’t touch it any more when it is triggered.

Secondly, this trader complained that he had overtraded. This is a natural response to losing while trading. We want to fight back. Unfortunately, trading is not the place to do it. What got this trader in trouble is not having a Risk Management Plan.

Here is a sample:

  • Trade normal size until I have a net loss of 3 pts
  • Following that, I cut my size in 1/2 and continue to take only my highest probability setups
  • If I take 2 more losses on my highest probability setups, I’m done for the day.
  • If this occurs again for the week, then I’m done trading live for the week.
  • My daily loss limit is 10 ES points. If exceeded, then I will not trade the following day but will continue to observe, journal and study the market.
Without this kind of strategy in place ahead of the trading day, you are taking the same risk as to say, "I am going to show up at the market open and then decide what trades to take depending on how I feel." We all know how well that plan works.

Taking losses is part of trading. It is not any different from being a quarterback, doing your best not to be sacked but being prepared to be sacked every once in while. A quarterback will protect the ball or have a plan of disposing of it, if he knows he that his offensive line has failed.

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2 Comments
  • Tom
    Posted at 21:13h, 02 December Reply

    Great psych issue but isn't it interesting that every ques dealt with trading mechanics, not psychology. This guy blew up b/c, in the phrase of Daniel Goleman, author of Emotional Intelligence, he was "emotionally hijacked". After a certain amount of loss all he cared about was getting it back. Having a plan would not have helped him. He was incapable of following any plan b/c his emotional circuitry was dictating his actions. Because he was unaware of his emotionality and how the brain processes the emotional information he had no choice but to revenge trade to try to get his losses back, thus causing more losses. I know b/c I did that for years. Learning how the brain processes information and how one's emotions affect how the brain processes info is crucial to avoid being emotionally hijacked. traderpsyches.com is the only place out there that deals with the cutting edge research of how our brain deals with making decisions under conditions of uncertainty and has turned my trading around 180 degrees and I highly recommend that everyone check it out. That said it is absolutely necessary to have a hard stop daily loss limit set with your clearing broker b/c anyone can get emotionally hijacked at any time and you won't realize it until you've blown a big piece out of your account. How many times have we all been there???

  • E
    Posted at 22:34h, 02 December Reply

    Offense is required, but Defense wins ball games.

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