Sit next to a pretty girl for an hour, it seems like a minute. Sit on a red-hot stove for a minute, it seems like an hour. That’s relativity.
– Albert Einstein
“Execute your losing trades immediately upon perception that they exist. When losses are predefined and executed without hesitation, there is nothing to consider, weigh, or judge and consequently nothing to tempt yourself with. There will be no threat of disaster.” These are the words of Mark Douglas in “The Disciplined Trader” and cover that painful topic of loss when trading. Something every trader has to deal with.
In the book “The Mind of a Trader” Patrick Arbor, former chairman of the Chicago Board of Trade, talks about the maxim that “Your first loss is your best loss”. He explains to Alpesh Patel that most traders don’t follow this though because “A lot of it is measured by pain – pain to the pocketbook, pain to the wallet, pain to the psyche.”.
Obviously much of it in fact comes down to ego as whilst a trader might intellectually acknowledge that losses are to be expected, Mr Arbor notes that “it (ego) plays with you, because we all like to think that we are smart and like to have confidence in ourselves.” It is the self belief and confidence that a trader needs to succeed that is also their potential downfall as it drives the need to protect the ego and thus open up the risk of increasing losses.
Mr Arbor goes on to make the observation of one of the absolutes of the markets and trading: “The market is always right. No one is smarter than the market. I have seen people come down to the floor with IQs of 150, PhDs, MBAs from Harvard, and not do well because they think they are smarter than the market.” You will not outsmart the market, the winner is the one who moves with it rather than spends energy trying to beat it.
So if you accept that losses are inevitable and the market is always the controller, it becomes easier to move on and focus on the next trade. That increases the probability that the next trade will be a profitable one. So the real question is, what actions you can take to ensure that you don’t get consumed by the losses?
Firstly you need to fully accept that losses are normal, to be expected and take it in your stride. The game is percentages and if you start by expecting to lose but focus on the fact that overall you should win ‘x’ percent of the time, the knock to the ego isn’t as great.
Whether talking about baseball, soccer or other such sports where the statistics on a player show their success rate, you know that they strike out, miss the goal etc more than they hit it but it is the overall consistency of their performance and ability to deliver enough times that sets them apart from the other players. So apply the same to trading and recognise that you win often enough and so as to take the pressure off each individual trade.
Next, it is essential to identify and quantify the risk before even entering into a trade. Indeed your trading strategy should include risk acceptance and identify your potential loss versus reward. The latter should be greater to the former which means you can relax and enjoy the process of watching the market and seeing if you pitched it right.
Finally the plan should also have given you clear exit points for both profit taking and loss containment so if the market goes against you, you can execute the plan without emotion. It is worth from the outset of trading, to practice exiting a trade when it’s gone against you and to get used to seeing the negatives while also starting with small amounts so the losses are really minimal. This way you learn not to let your ego get in the way but to accept it as sound business practice.
Most importantly, never see a loss as personal. It’s not about you. It’s the markets and ultimately they will always retain the final control. The trick is to see that you are not defined by your losses but how you execute your trading plan and that acceptance of “your first loss is your best loss” is the key to opening yourself up to bigger returns in the long run. This in turn will lead you to become one of the rare consistently profitable traders.
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