As we know by now and especially after the recent vicious market downturn, losses and the act of taking losses is a "necessary evil" in trading.
Bo Yoder, one of my favorite traders whom i used to follow religiously in my earlier years as a trader wrote some very good stuff in his book "optimize your trading edge"... he discussed that ALL trading systems will go thru a "pay-out cycle" and a "pay-back cycle".
The PAY-OUT cycle is when your system is winning and making money consistently
The PAY-BACK cycle is when your system is going thru a losing streak and losses are becoming more frequent.
A trader's job is manage himself as professionally as possible thru BOTH these cycles.
Here's the way i look at taking losses while trading:
Needless to say, the hardest part about trading is TAKING A LOSS, closing a trade for a loss. It's hard not only because it means that you will have to incur an actual loss to your equity which obviously will decrease your account size but also because as emotional, rational, thinking human beings, as traders we all want to be RIGHT! .... Nobody wants to be wrong of course..... but as we all know, this is NOT the reality of trading!
You have to get into head, that there's ABSOLUTELY nothing wrong with getting into a mistimed trades:
That happens to EVERYONE regardless of experience. It's an inevitable part of this business. Trading is a business, just like any other business.
There's nothing wrong with making "mistimed" entries in trading but the biggest mistake one can make is stubbornly REFUSING to obey the stop loss of a trade. When human ego is on the line, as traders, we sometimes do things we otherwise wouldn't do, especially when money or "reputation" is on the line.
Again, there's nothing wrong with losses as long as they are taken within your system's or within your specific trade's game plan.
It's much easier to recover from a 2% or 3% or 5% LOSS rather than digging yourself out of a big -20% draw-down(we've all been there, done that and we all know the horror of it).
Recovering from a large draw-down is a challenging and frustrating. It messes with your head and creates all sorts of emotions like anger, despair, hopefulness and so on. It will affect you psychologically and affect your personal life too in some cases.
All traders will learn this the HARD WAY unfortunately(maybe even a few times before it really sinks in) but rest assured everyone has done it and it's not fun.
The best thing to do, I've found is to respect the stop loss, take the initial LOSS. Think of trading as a business like any other business. Every business will sooner or later have to incur a "loss". For example, a grocery store that's carrying expired inventory, an Auto manufacturer who recalls a faulty car part or maybe even a bank that's made bad loans and now all have to incur these losses, as "business expenses".
Taking losses in trading, has to be seen as a routine "business expense". It's part of doing business we are in.
But now comes the tricky part of this business, how can i recover mentally when i just had a disaster week and made several losing trades in a row? My confidence is shot, I'm disgusted, I'm angry, I'm frustrated and I want to make that lost money back ASAP!
Oh boy, don't we all know the feeling of that?!
After many years of being in this business and making tons and tons of mistakes of all shapes, sizes and colors.... I've implemented the "3 losses in a row" rule. What I've noticed over the years that for my style of trading and using my system of trading, that any time, i took 3 losses in a row, regardless if they were big, small or routine losses, i automatically know that something is wrong and i need to STOP TRADING completely. Do a "time out" in whatever you're doing and take a big step back.... The "3 losses in a row" rule forces me to sit out the ENTIRE day and not trade at all. I will shut down my twitter, CNBC and any other source that could tempt me from making a knee-jerk reaction trade.
The goal is sit out the entire and do nothing, walk away completely and do something else... once the market is closed and i feel a little more relaxed, I'll now want to see what triggered the 3 losses in a row and what could i be doing wrong? What am i missing? Is there anything that needs to be tweaked? Are the market conditions changing? Which trades worked and why? Which trades did not work and why? Have i done something different or deviated from my system? Am i being "honest" with what I'm seeing(or think I'm seeing) versus what's actually happening in the market?
Over the years, i realized that most of the time, whenever i take 3 losses in a row, it's due to a change in "market character" and my positions were caught on the wrong side of the tracks... so that requires immediate attention.
As i mentioned in that blog post from 7 years ago: Things I Learned After 15 years of Trading : "get aggressive after you make 2 or 3 good trades in a row, get very defensive when you make 2 or 3 bad trades in a row, often times traders will do the exact opposite, self-destructive behavior".
Naturally emotions are going to be higher than usual at this moment, so you should instinctively know that any trade you make on this day after taking 3 or more trades in a row, these trades are most likely gonna be emotionally driven and chances are high, these trades will not work out well.
The ideal thing to do is shut down completely and walk away for 24 hours... give yourself one full day off from any trading. The market isn't going anywhere, it'll still be here tomorrow so relax, you're not going to "miss out!"
Make this a MUST-FOLLOW rule! No exceptions, no ifs, ands or buts.
Shut down and walk away for at least 24 hours.
Once you've cooled off a bit and you're ready to get back in the saddle the following day(or 2 or 3 days later ideally), you have to instantly eliminate from your thinking the idea of "i'm gonna make back all my losses in this next trade!" This way of thinking is 100% flawed and is a very typical amateur thing to do. We've ALL done it before and we all know it's silly and a self-destructive way of thinking.
Trading is a marathon, not a 100 meter sprint!
Relax, take a deep breath. You will make back your losses but it will not happen in ONE trade, it could take several trades and that's TOTALLY FINE .... the world will not end today if you don't make back that loss from yesterday.
This is not how professional traders approach a "recovery phase".
so for example, the last thing i want to do is get back to my desk the next morning and go long a stock like TLRY on margin to make back the losses from the previous series of trades. This will only add more emotions back into the mix and you will make more mistakes and trading losses will pile up quickly....
You have to focus on rebuilding back up SLOWLY. In a cool, calm and controlled manner.
You have to focus on rebuilding back up SLOWLY. In a cool, calm and controlled manner.
What i like to do is come back the following day and start looking for SAFE and EASY to trade ETFs and take the next series of trades using only 1/2 size positions. I'll often focus on taking only the HIGHEST QUALITY setups in ETFs. I want to focus on doing the "small things" and getting the absolute basics done right. Waiting for the absolute best and easiest setups, my "bread and butter" setups and executing this trade properly, raising stops, booking gains. I want to focus on the basics and doing the basics right. The goal is not to "make up losses immediately".... No, that's NOT the goal right now. Right now, i need to make sure that I slowly build up my trading confidence because i know when I am doing the small things correctly and focusing on find good setups, waiting for the good setups and then EXECUTING the good setups, then this is what's going to rebuild up my confidence for the next series of trades. You'd be surprised what ONE small little green trade can do to your confidence.
ONE DAY AT A TIME, ONE TRADE AT A TIME...
Another important point to keep in mind: traders have a "breakeven mentality" when it comes to losses. Some traders will even refuse to sell a position that going against them in a very dramatic manner simply because they just want to "breakeven" and then they'll sell it. You have to be very careful when you start catching yourself thinking like this. This will land you into deep waters and into some very painful trades sooner or later.
Traders focus too much on PnL to the point that it hinders their progress and often times just end up trading purely based on their PnL's fluctuations and not based on actual setups and their system's trades. Totally failing to understand that if you're focusing on trading well, stop looking at your PnL, only focus on finding and executing the best setups and doing all the simple things right, the PnL will take care of itself.
Stop obsessing about your PnL and start obsessing about trading your process, your trading system, and executing your trades well... the PnL will take care of itself.
I hope you found this post helpful!