HOW TO HANDLE LOSS
“If you can learn to accept a loss you will be a successful trader.”
My face must have shown a strange expression as the saying messed with my head. I knew I was receiving a great piece of wisdom from experience, but it wasn’t quite gelling. My mentor went on …
‘Accepting a loss frees you up to make another winning trade. It frees you up psychologically and releases your capital to go find another winner.
It was starting to become clear. If I could accept that losses in trading would occur, I would be released from the fear, and free to make winners.
‘The key is to protect your confidence to trade. We know how to always go back and get more money, but if you lose your confidence then you are in trouble.’
This is where many beginners get stuck. They don’t want to lose. However, it began to dawn on me that there are a few businesses prepared to make some small losses in order to be profitable. In fact it is seen as the cost of doing business.
Do insurance companies make losses? Of course! People make claims, but before the insurer offers a policy they carefully assess the risk of a claim from that individual or organization. Then they make an offer. They know they will have to make some payouts in their budgets, but the odds are stacked in their favour so they will make a profit. Additionally they get underwriters to protect them from extreme fall out.
I once spoke to a technician whose job it was to keep the poky machines in order at a casino. At the time the machines were programmed to give away 10% of their takings. This was enough to keep the punters coming back for more in hope that they’ll strike it rich. Meanwhile the house pocketed a whopping 90% profit.
My mentor began to show me how to stack the odds in your favour, to make consistently winning trades, as a casino or an insurance company would.
‘For example let’s say you made 10 trades. 8 are winners, 2 are losers. The 8 winners make you $1,000 profit each, and the losers take $2,000 each from your bottom line. You are still ahead! 8 winning trades of $1,000 minus 2 losing trades of $2,000 each ($8,000 minus $4,000) equals $4,000 profit for the effort! The game of probability has worked in your favour!’
At this point the light began to burn brightly in my understanding, and the shift away from being afraid of losing money started for me. To some extent trading is a mathematical formula of probability.
The thing is we have been programmed to never lose money. This often comes from a mindset of scarcity rather than a place of abundance. Now don’t get me wrong. When a losing trade goes against you, it is absolutely imperative to cut your losses swiftly and quickly, and not let them linger as you are setting yourself up to lose a lot of capital. Defending our capital in trading is absolutely paramount. But to never be prepared to make a losing trade is unrealistic. Provided the winners outnumber the losers with prudent risk management, a trader should be successful.
The taste of a losing trade can be bitter. I find that when I have incurred one, I don’t dwell on it too long, and will generally roll down by selling into a safer position very quickly to recoup losses and defend my account size. I want to regain those funds quickly, knowing my confidence will pick up as soon as I’m back in momentum making winning trades.
It’s funny too, as soon as you take that loss and accept it, . Once I’ve done it, I am looking for the next winner.
I’ve heard of traders who won’t accept a loss. One lady would not accept a $5,000 loss. She stayed around hoping for dear life it would turn around. I can only assume what was lost was more capital than necessary, and that new opportunities to turn around the loss quicker with winning trades as her margin and capital were tied up in a losing trade. It was a case of holding on to the old and not moving on quickly making the trade worse than it should have been.
Trading involves developing a mindset of resilience. It’s the ability to bounce back. I am never one to go whining on how bad the market is. It’s not the market that is at fault. If it’s not working, the fault is with my strategy. And that’s where the adjustments must be made.
As another mentor put it to me, ‘The market is NEVER wrong! It’s the strategy that’s wrong!’
I always find it fascinating when a trader or some economists get into analytical mode. They argue how a stock is not corresponding with the price it should be. A stock is never a ‘should be’ price. By that I mean a stock is always the price the market is saying it is. Such statements such as ‘The stock fundamentals are all right, but it isn’t being matched in the pricing’ are crazy. Or ‘The market is making a correction!’ A correction from what? These are all dangerous statements in my book. They are either excuses on why you got it wrong, over theorizing what a perceived stock price should be, or they are second guessing what the market might do.
When I buy two litres of milk from the store I never go into the fundamentals of what the price should be, or if the market is having a correction, or what emotional state the cows are in at the moment. The price is what the price is. At different stores prices will vary, and I have a fairly good idea where the better prices are more consistently presented.
It’s the same in trading options over stock. The stock price is what the stock price is. It may vary over a period of time, but in that moment of trading it I’m not considering what it ‘should be’. I’m trading what it is!
When a trader starts to trade they must accept they are stepping into a new level of responsibility for their actions. Blaming factors beyond your power for what is happening, or your perception of what ‘should be happening’ is never a helpful exercise. You have to be real. This is the market price. Deal with it!
How to handle profit
The flip side to a loss is what we all want – a profit. And it’s amazing how this can also be psychologically sabotaged.
It’s a bit like the lottery winner who within a few years returns to having nothing in their account after earning a seven figure win. They aren’t used to handling that kind of money and something within them longs for the safety of not having anything. It is sabotaging their results.
There are a lot of self-esteem issues here at play and if not addressed will interfere with results.
The danger is running out of patience, taking on risks they shouldn’t, only to give all the profits back to the market, and start back at square one or worse still further behind. Traders must protect their capital!
We all know what the upside can be. It’s the downside we need to consider.
Additionally you can also experience a phenomena we’ve called ‘Anxiety to Trade’. This is where you’ve had a number of wins, you are looking to trade, however the market isn’t presenting an opportunity. There can build up an over-desire to take a trade, even if the conditions aren’t lining up. It’s important to be aware of this. Not having a trade sometimes is a trade. In other words, on occasion the most appropriate trade you can place is not having one. Sitting on the sidelines looking for opportunity is occasionally part of it. Patience is important.
Just as a fisherman has to wait for the right one to come along, sometimes they just aren’t biting. This can be frustrating! A trader must remember they can’t make something happen. Either a trade is presenting or it isn’t!
The key here is to understand it all must line up from the word ‘go’. You can’t expect a trade to correct itself, or come good if it isn’t right at the beginning. While I’ve seen errors placed on trades and sometimes a trader can get away with it profitably while correcting it, it’s key to remember – it must line up in the beginning!
Overall here are the psychological stages I go through when I trade. I look for an opportunity, and will often form a list of what is presenting. From that list I will often assess what appears as the safer trades, attempting to find the healthy balance between risk versus reward.
While entering a trade I’m always conscious of what can happen if it goes wrong, and want to err on the side of conservative rather than aggressive. I want enough fat on the trade to ensure it’s worth my while getting in, and also have enough profit to absorb the cost of closing out early to ensure it’s a winner when given the opportunity. In other words I’m prepared to give a bit of the initial payment I receive back at a later time, to lock in a profit, and go for safety.
Once I’ve placed the trade my mindset now switches to ‘Anything can happen.’ This places me in a state of vigilance. If the trades are going my way I’m in ‘babysitting mode’. I let the market do its thing, and let the trade go that way. I’m then looking for exits to lock in a profit.
If it is starting to move against me I watch it like a hawk. If things get too close for comfort I have a very systemized approach which I default to. If I decide that action is necessary and the trade is a loser, I will swiftly without hesitation or second guessing myself put my defense plan in place always protecting my capital.
And it’s the losing trades that always take up more of your energy, time, and attention than the winners. So often I will go back and run a report on my trading to identify which stocks I trade that give me the most consistent and profitable results. They can be easily overlooked.
HOW TO HANDLE CHANGE
It’s been said the one constant in life is change! And this is what traders face.
You have to realize that markets change and so must businesses. They are in a constant cycle of give and take, buy and sell, profit and loss, ebb and flow. Government policy, regulators, and even the broker can change the rules in an instant, and as result there’ve been times where I’ve found one particular strategy doesn’t work anymore. These are economic realities.
I once remember I was getting great success in a bull market trading a strategy I no longer fully utilize. Everything was going well until the markets got spooked due to what was happening in Europe at that time. Suddenly I found my strategy starting to unravel. I worked on my mindset, followed my defense mechanisms and found there was a hole in my strategy at the time.
As a consequence I had to change. Instead of blaming the market and all the other influences out of my control, I realized there were flaws, which set me on a journey to find a patch to fix what I was doing. This started another chapter in my development as a trader to find a strategy that would work in all market conditions. It made me stronger. What I’ve noticed where some investors fall down is they get emotional. Rather than searching for solutions they either give up, or worse still try to find someone to blame. They react rather than respond. The mature response is to pull away, analyze, and turn their energy and focus into an opportunity to become better at what you do. It’s about problem solving. Traders must understand the risks, be responsible in behavior, and become resilient.
Additionally I find so many new traders are looking for “rules”. Now don’t get me wrong on what I’m about to say. Rather than rules, what’s more helpful are strict guidelines. And I say this because sometimes in following strict rules, common sense can be thrown out the window rather than having the flexibility to adjust to the changing conditions. If we are always trading with confidence with safety 1, 2, and 3; stacking the odds in our favour in the game of probability, utilizing trading tools to give us an educated guess at best as to what MAY happen, recognizing that things will come up, and having the prudence and wisdom to remain flexible to respond rather than react to those changes; then the odds are certainly increased as a system is followed to derive a certain outcome.
Always sticking to a rule can choke out a creative solution. Again I always err on the side of caution, if I’m testing something I do so with very limited risk to prove to myself it will work. This of course plays more into the second stage in learning to trade – the subjective.
Additionally it is important that traders remain emotionally detached from the stock they are trading. It’s dangerous to become infatuated with your stock. When someone goes on about how great a company they have in their portfolio is they are speaking in accumulator/owner language. For a trader, stock is merely there to provide an opportunity to trade an option around it. It’s a tool to produce cash flow. Where and how you place yourself in relation to the stock’s price movement determines your success.
And the fact that the markets and stock go up and down is the very thing giving you the opportunity to profit from it. If it remained constantly stagnant, there would be no risk. Additionally there would be no reward, neither opportunity to trade.
I’ve found for anyone beginning to move into this area of trading the new normal is ‘uncertainty.’ You are taken out of your comfort zone, into the place of the unfamiliar. And by the virtue that it is unfamiliar it feels uncertain, because there are so many unknowns!
This new place is exciting. However there is never any room for drama in trading. Some people get into trading as they have a need for escapism. My goal has always been to make trading so systematic it’s boring and mundane. This keeps me in a balanced psychological and emotional state. However even the masters salivate when it comes to talking about trading options. It is incredibly addictive and keeps us coming back for more.
The ideal state of trading is staying calm, balanced, and relaxed. And the more a trader trades, and experience various market cycles the more they grow used to the feelings of uncertainty. The more skilled they become in handling the emotions of greed and fear. And the more experienced, the more familiar they are to know what to do, and are less concerned about all the unknowns.
The key psychological gems that guide me in my trading are:
Always protect your confidence to trade
1. Always go for safety one, two, and three
2. Learn to accept a loss
3. Once in the market realize, “Anything can happen.”
4. Be patient. Always assess risk vs reward and make a wise decision from there.
5. Always defend capital
6. When there’s a profit to be made, take it!
7. Things will change. How you respond, rather than react, is the key!