As traders, we all know by now that taking 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. Trading feels good and is fun! You're winning, a lot!
The PAY-BACK cycle is when your system is going thru a losing streak and losses are becoming more frequent, getting stopped out on many trades! Trading sucks!
A trader's job is manage himself as professionally as possible thru BOTH these of these inevitable cycles.
These cycles often times start at any moment and can start for any reason. It could be one really poorly timed trade, or one unlucky trade(like my recent Boeing trade after the Ethiopia plane crash for example) that haunts you psychologically or it could even be an external life changing event, such as stress from a divorce, anxiety from a recent job loss, or heaven forbid an untimely death or illness in family etc). All these things can trigger a "PAY-BACK CYCLE".
PAY-OUT CYCLES can start after you have accepted the fact that you just went thru the PAY-BACK cycle, moved to 100% cash for a few days to "push the pause" button. You've come to terms with the situation and now feeling mentally more relaxed, focused, ready and hungry to trade WELL and with more discipline(keep in mind, there's a big difference between being hungry to trade and hungry to trade well).
Here's a good way to 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!
A traders, we have to accept the fact that there's ABSOLUTELY nothing wrong with getting into a mistimed trades:
That happens to EVERYONE regardless of experience. Losses are an inevitable part of this business. Trading is a business, just like any other business.
Recovering from a large draw-down is a challenging and frustrating. It can mess with your head and creates all sorts of emotions like anger, despair, hopelessness and so on. It could affect you psychologically and affect your personal life too in some cases.
All traders will sooner or later learn this this HARD WAY unfortunately(maybe even a few times before it really sinks in) but rest assured everyone goes thru such losses and draw-downs. Many new things will surely be learned along the way and will build your trading character.
The best thing to do, I've found is to have STOP LOSSES in place and know what you're willing and ready to risk on any single trade and let the market take care of itself even if it means getting stopped out for a 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". Some losses will be larger than others. It's a natural part of the business we are in. Embrace it, don't fight it.
But now comes the tricky part of this business, how can i recover mentally when i just had a disaster week or month and made several losing trades in a row? My confidence is shot, I'm disgusted, I'm angry, I'm frustrated!
After more than +20 years, 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, 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 step back.... The "3 losses in a row" rule forces me to sit out ONE 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 day, 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 is the market doing that I'm not seeing? 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. For example, the market went from being TRENDING UP nicely to now being choppy or even entering a pullback phase. That's the change of market character that often triggers losses and usually requires traders to take precautions.
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 during this time, so you should instinctively know that any trade you make on this day after taking 3 or more trades in a row or even a large loss from a single trade, these trades are most likely gonna be emotionally driven and chances are fairly high, these trades will not work out well. This is something that every trader will go thru, even professional and new traders will suffer from time to time. We are all human beings in the end, we're not perfect machines.
The ideal thing to do is shut down completely and walk away for at least one full day... give yourself that break.
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!
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 trader 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!
ONE TRADE AT A TIME, ONE DAY AT A TIME.....
Relax, take a deep breath. You will make back your losses and then some but it will not happen in ONE or TWO trades, it could take several trades or several weeks and that's TOTALLY FINE .... Rome wasn't built in a day and neither will your trading draw-down.
Baby steps, ease your way back into your routine... until your confidence starts to come back, slowly slowly....
For example, the last thing you want to do is get back to your desk the next day 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....
Focus on rebuilding back up SLOWLY. In a cool, calm and controlled manner. Focus on trading well. Taking the best setups even if it means having to wait another one or two more days. Adopt a "LESS IS MORE" way of thinking.....
What i like to do is come back the following day and start looking for SAFE and EASY to trade ETFs and/or take the next series of Stock setups(triggered trades) using only 1/2 size positions and give them looser stops. I prefer to focus on taking only the HIGHEST QUALITY setups in ETFs or the highest quality individual stocks and stock setups. Go back to basics and focus on doing the "small things" 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 eventually.
Never underestimate the power of small gains. Small gains add up to big gains over the long run so don't hesitate to take those small gains!
Make it a great week!
I hope you found this post helpful!