Losing gets a bad rap.
If you’re like most people you do all that you can to avoid losing. You go to great lengths to win… or at least to be seen as a winner. In the case of trading, you avoid losing trades in much the same way that you would avoid someone known to have the Bubonic Plague.
And that is likely why you haven’t turned the corner to consistently profitable trading.
Winning is fun.
Type winning into Amazon.com under books and you get more than 28,000 results [as of May 2012]. Winning gives you the warm and fuzzies inside. It makes your parents proud to acknowledge their connection to you and, in some cases, to take varying degrees of credit for your success. Winning even makes you more attractive in whatever dating pool you choose to play.
Unfortunately, winning can also present its own unique set of difficulties.
You see, try as you might, when you win something deep inside you attributes that win to you. Steps that you took. Decisions that you made. Or, when all else fails, to your good luck.
The opportunity for close examination of the win becomes a casualty of your need to celebrate… or to at least bask in the afterglow of the win. You lose the ability (or willingness) to determine exactly how your good fortune came about. In other words, the opportunity cost as measured by your understanding of your win can be extremely high.
You “just won baby…” You don’t much care how.
But if you don’t know how to lose properly, it’s only a matter of time before you lose it all.
In the minds of most people, failure and losing are synonymous. In their minds, a loss is the result of a failure of plan, strategy, tactics or execution (or some combination thereof). As such, losses must be attributed to someone… anyone…
Blame must be placed…
Or at least that’s what we learn from a very young age.
Once the blame is properly placed, that loss is usually given substantially more significance than it deserves. The person found to be responsible is labelled a loser… not someone who suffered and/or contributed to a loss.
Since it is clearly not your fault, this allows you to remain “a winner” or at least someone who has not lost.
And the damage is done.
You become consumed with maintaining your lossless record. Whether that requires that you avoid stepping up to the plate at all or whether it makes you double and triple down to avoid accepting a loss by throwing good money after bad. Anything to avoid accepting a loss.
That avoidance becomes all consuming.
Which is the absolute wrong approach to losses and generally leads to the aforementioned “losing it all.”
The Right Approach to Losses
First of all, understand that losses are a necessary part of any risk taking activity.
The goal should always be to blunt (minimize) the impact of losses as opposed to eliminating the losses altogether.
There’s a distinct difference between minimizing the impact of losses versus minimizing the number of losses. If the money you’re risking stands between you and hunger, think twice before placing it on the line. Risk capital must be true risk capital.
Second, losses are better teachers than wins.
As noted above, wins often lead to complacency. Losses usually compel you to figure out “why.”
If small and incidental to your overall strategy, they confirm that your plan is working. If relatively outsized and/or unexpected, losses make you examine the precedent trades and determine if your strategy should be adjusted.
This is how advancement happens in the world of speculation.
Thomas Edison needed nearly 10,000 tries to find filament for an incandescent bulb that would last for more than a few hours. Of the thousands of attempts that did not produce the bulb, Edison didn’t see them as failures, but rather as just ways that didn’t work. This proved to be useful knowledge in and of itself. By knowing what didn’t work, Edison was able to find his way to what did.
Containing and then examining your losses will help you do the same with your trading strategy.
Third, recognize that losses that are kept small relative to your portfolio are a big part of the fuel that propels your account higher. Small losses say that you’re taking prudent steps to grow your account… that you’re “in the game.”
The alternative, especially if you accept that losses are a necessary part of trading, is take no risk approach or the taking of outsize risk (refusing to cut losers).
Neither of these provide a path to account growth. I’ve tried it both ways… and if you believe nothing else I say, believe that.
If you can find/develop a trading method that allows for (in fact, embraces), many small losses while still delivering profits overall, you will have gone a long way toward eliminating the trepidation that most new traders feel about entering the fray. You will also be able to stop worrying about having the “right” picks.
In other words, you will be well on your way to becoming process (as opposed to outcome) focused. This is a giant step in the direction of pulling consistent profits from your market, but it’s also a post for another day.
As a trader, you will find that the search for the “Holy Grail” is never ending.
You can’t ever “get there” but you can get close… and becoming a better loser will help speed you along the path.