In trading, you are in control of everything you do. The market can do whatever it wants, so the only thing you need to focus on is your edge, trading system, and behavior. You cannot directly control whether your trades will be winners or losers.
However, the magnitude of the winners and losers are completely in your control. And what you need are small losers and big winners, especially if your system has a lower win rate.
If you can eliminate big losses from your trading, you will be taking a huge step in the right direction towards consistently profitable trading. So how do big trading losses happen? And what can you do to avoid them?
1. Stubbornness
It is in our nature to have difficulty admitting when we are wrong. Our ego is a huge barrier to success in trading. It doesn’t matter how much conviction you have in your ideas. A junk company can run up 100’s of percent without pulling back. A great company can have as many red days in a row as it wants.
Price action is always king. If you cannot learn to respect price action more than your ideas, you will never make it as a trader. If you find yourself consistently taking big trading losses, use hard stops to take yourself out of the market, so the decision is automated.
2. Oversizing
Trading too much size is a huge problem in many new traders’ trading. Stopping out of trades that you have a lot of size in is a difficult thing because it means you have to deal with the reality of that money leaving your trading account.
You should be trading size that doesn’t make your hands sweaty, and you feel like you could leave the computer for a few minutes while your position is on. Taking the loss should barely affect your net worth.
Imagine if you had a $30,000 trading account and you lost $200 on a trade. The loss would barely affect your day. If you have losing days that you get extremely emotional over, and lead you to pound 10 beers to cope with the loss, you’re trading with too much size. You have to trade with size and money that you have very little emotional attachment too in order to make calculated trading decisions.
3. Adding To A Losing Position
The longer you are in a losing a trade, the more likely it is that you are on the wrong side of a trend. A lot of traders think they will be making an eventual winner bigger when they add to a losing position.
The reality is, and the more probable outcome, that you are just going to end up taking an even bigger loss. You should be adding to your positions when you have a winning position already and you have a cushion.
4. No Trading Plan
Lack of preparation usually leads to bigger losses because you did not prepare an exit strategy. A lot of new traders think that as soon as you buy or short a stock it will immediately start going in your favor in a completely linear manner. The reality is that anything can happen in the financial markets.
So you have to make a plan for when the stock goes in your favor AND if it goes against you. You have to define the worst-case scenario for each trade you take. If you don’t, you open yourself up to the chance of taking huge trading losses that wipe out weeks and months of profitable trading.
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