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How Losing Makes You Win
How much money should we lose?
That’s not a question that most traders ask before they press the buy/sell button, but it is perhaps the only question you need to answer if you want to trade well.
Nobody ever starts trading because they want to lose. Everyone gets involved in the markets because of the tantalizing prospect of big wins. But the reality is that most traders lose big precisely because they never think about losing properly.
If you are day trading like we do in the BK chat room, losing is simply part of each day. The more trades you take, the more stops you’ll have. That’s just the nature of the markets. The key is always to control the losses.
The first and easiest way to do that is to automatically wrap each trade with a stop and a take profit using the simple buy/sell scripts I shared a few weeks ago. Doing that will ensure that you don’t have a “dangling” order whose loss can quickly grow out of control due to some “news bomb”.
One of the most common mistakes traders make is that everyone wants to fight sentiment. When markets turn against you the universal instinct is -- “it will come back”. And 8 out 10 times it usually does. But the 20% of the time that it doesn’t, comprises 100% of the cases of all blown accounts. Having an auto stop attached goes a long way towards avoiding that nasty scenario.
The other great risk control tool is simply size. Size however is not just a function of your risk tolerance but of the frequency of trading as well. A trader who has a 10,000 account and trades once a day at 10:1 lever factor could trade 100,000 units of currency. The very same trader who day traded 10 times that day would only be allowed to trade 10,000 units per trade in order to maintain his leverage factor. This is something that most rookie traders miss completely. If you day traded 10 ten times at 100,000 units each -- your total turnover would be a 1M and you would have basically levered 100:1. (Yes I know that mathematically that is not quite true, but for trading purposes it’s much closer to the truth than not, which is why everyone should think of leverage this way)
My own personal preference is to trade no more that 1 times my equity on any given trade (that includes all the add-in positions I may employ). Generally, my starting trade on my 25,000 IRA account is 5,000 units which may be too conservative for some but suits me just fine, since I expect to make 20 trade each day (there is that frequency lever multiplier).
The very last question you want to ask yourself is how much am I willing to lose each day? Again that is a function of personal preference, but my hard rule is never more than 1% of the account. So far, I have not come close to hitting that limit (mainly because my initial opening size is small) but if I ever do -- I will close all positions and stop trading for the day.
A 1% equity stop on your account may not seem like a lot, but if your goal is to make 10 basis point per day than it is just right. In fact that is a very good rule of thumb to use. Take your daily goal target (assuming it is realistic of course) and multiply that by 10. Put a hard stop on your equity at that level and never, ever, question or doubt that move. Any loss that takes more than 10 days to recover is going to be a very difficult task to achieve. Don’t make trading any harder than it is.
Know your losses ahead of time and you will set yourself up for the wins.