How To Lose Like a Winner
Yesterday I got a call from a trader who was short USD/JPY from 103.50 and had build his position to such a size that he needed to drop more into his FX account. What to do? Well I never give out individual investment advice but I tried gently to walk the guy off the ledge by making him focus on his “uncle” point.
“You need to ask yourself what the maximum you are willing to lose and stick to that number,” I told him.
He thanked me profusely, but I hung up the phone with a sinking feeling that he was going to ignore my advice and hold on until the trade either retraced or he got margined out.
Its easy to make fun of such typical retail trading behaviour but the truth is -- ALL of us have done this many times. We’ve all been in a trade gone wrong, refused to get out at a loss, added to the position and then applied the worst trading strategy of all -- HOPE.
Ironically enough at the time of the phone call I myself was nursing two runaway positions that were against me, but my situation was radically different from the trader who called me. Experience taught me to lose like a winner.
Let me run you through the trades to show you what I mean. Yesterday, which was the biggest day of decline for the EUR/USD in more than 3 years I decided, that the move was overdone and got long the pair a bit below the 1.3000 mark. Now this trade was based on nothing but “feel” and was basically probative.
My other “brilliant” trade idea yesterday was to short AUD/NZD from around 1.1230 -- because it was “way overbought”.
When you are trading your “gut” then the single most important thing to do is to throw as little money at the market as possible. When you don’t have a clear target or a well defined stop small size is crucial. My initial foray was only 1/3 my equity on a notional basis that means I was at 1/3 to 1 leverage ( that’s right, I was trading LESS than cash on cash).
Because I really didn’t know where the top or the bottom were in these trades I was prepared to add a few times BUT -- and this is absolutely crucial -- I was only going to add the exact same size of my opening trade rather martingaling the position. In other words if my initial trade was 10,000 units any future adds would be no more than 10,000 units per trade. Martingaling (the art of adding progressively bigger size to your position in order to reduce your breakeven point) is the crack cocaine of trading. It may work once or twice, but it will ALWAYS bankrupt you in the end.
Lastly, instead of reacting to every tick against me, I stayed patient and watched the price flow carefully only adding to my longs and shorts after meaningful moves of at least 20 pips or more. By the end of the day I inventoried enough product that I was near breakeven on my EUR/USD but still out of the money on my AUD/NZD and this is where the bittersweet experience from the school of hard knocks came in handy.
If you want to lose like a winner you need to do two things. You need to be brutally honest with yourself and you need to manage your losing trade, rather than desperately hoping for it to turn into a profit. As I said earlier HOPE is not a trading strategy, even though it is the most popular strategy around.
Once you realize that the trade is not working your focus should shift to minimizing losses rather than maximizing gains and in the case of both EUR/USD and AUD/USD I quickly adjusted my exit points, getting out of my euro’s for a small gain and AUD/NZD for a small loss. Overall I managed to escape the day just slightly up, but even if I was slightly down I would have considered it a good day because I controlled my risk by losing like a winner.
So here is the summary of what I did.
1. When entering an undefined trade -- always start very small. Use no leverage whatsoever.
2. If adding to the trade never martingale
3. Add at spaced out intervals so that the breakeven point on your inventory is as close to market price as possible.
4. Have a time stop on your trade and be honest enough to recognize that it is not working.
5. At that point change your mindset from seeking profit to minimizing loss and work hard at closing out the position as quickly as possible.