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How to Fix the Most Demoralizing Thing About Trading
What the most demoralizing thing about trading?
Losing is by far the most demoralizing aspect of trading for anyone who tries it for longer than a week. Rookie traders sometimes catch a burst of beginners luck and will make five, ten, twenty winning trades in a row -- which is just about the worst thing that can possibly happen to them -- because they will then inevitably lose it all on one single trade as they fight the market. I’ve seen it happen so many times that it is basically the trader’s version of Groundhog day.
Losing carries with it all the joy of a sucker punch in the solar plexus when it happens to you. You just can’t believe that the market could be so stupid as to (rally, dive, whipsaw -- pick your choice ) so much that it stops you out (almost inevitably to the pip of a bottom or a top).
It is certainly painful to lose the money, but the damage to your psyche is much, much worse. You start to wonder if the game is rigged, or even if it isn’t -- if you are smart enough to play it. You want to succeed but begin to question if you ever will.
Generally, there are two risk control approaches when dealing with losses. The most common one is the automatic stop loss. For example, I trade with a script that always wraps a stop and a take profit on every entry I make. That way I never, ever hold a position with open-ended risk. I may on occasion adjust my stop, but I never lift it. ( Since doing that, by the way, I have never, ever blown up any account I’ve traded).
Stop losses are ok, but they don’t remove the demoralizing factor. In fact, they can sometimes increase it. You misread the market and then wind up catching three, four, five stops in a row. The death by a thousand cuts can be as painful as the blow from a single punch.
The other approach to risk management has to do with size. Stops are for suckers some traders claim. Trade small and you can ride out almost any move against you. Your account basically acts like a rubber band -- the market throws losses at you but the account bends rather breaks as all your equity absorbs the adverse moves and waits patiently until the market turns around in your favor. So this approach can work, but only if you trade super small. Let define what small is -- that’s basically 1:1 leverage or even 1:2 leverage where you trade a 10,000 unit size for every $10,000 in your account. Let’s understand why that’s important. If you allow the trade “float” it can go against you 5% maybe even 10%. If you are floating 3 to 5 different positions at 1:1 lever you have implicitly levered up 5 times and if the trade moves against you 10%, that effectively makes it a 50% move against your equity. So trading small means trading 1:1 lever MAX.
But even if you let the trade float, you are no less protected from both the monetary or psychic risk. In fact, the WORST losses I ever incurred were the results of letting trades float. The reason is that the market, (like your siblings or your mother) will always push your buttons. As the losses mount the psychological pressure becomes more and more unbearable. This is especially so when several negative positions “add up” and begin to weigh on your equity like a boulder on your chest. When that happens, I guarantee you, you will not sleep well at night, waking up every few hours to glance at the quotes. Furthermore, no matter how small you trade, eventually you will need to cut one or several of your losing positions, generally at a massive loss that will wipe out weeks, months, sometimes even years of gains.
There is nothing more demoralizing than that.
So what’s the solution?
Use stops like you have an OCD complex AND trade ultra-small. That may not sound very satisfying. You may never make 10,000 dollars on a $1,000 account in one single well-placed trade, but trust me you WILL be able to stay in the game for years and years and will get better with every month that passes.
The key to good trading is not winning strategies or brilliant analysis -- both help -- but just mildly. The key to good trading is the speed of the recovery rate. How fast can you recover from drawdown? If you can achieve a recovery rate of one week or less -- you are on your way to success. The money will take care of itself. That’s why trading super small and stopping quickly is the better way go. And just in case you need to motivate yourself consider this.
The best hedge funds in the world do 20% per year.
If you take $10,000 make 20%/year and add $5,000 from saving to you trading pile each year you will have more than 1.5M in your account in 20 years time.
20% is equal to 2000 basis points
There are 250 trading days in a year.
That means you need to make 8bps or 8 pips each day to achieve that long term goal.