Something that is a given when trading the markets is loss trades. But it’s the lessons learnt from these losses that go far beyond the money lost during unfriendly market periods. How well traders and investors put steps in place to ensure that their long term performance can be enhanced is dependent on the degree to which a trader accepts that losses and drawdown are a natural occurrence in the market.
No successful trader or investor would disagree with the fact that trading psychology is just as necessary as the strategy or market methodology. Trading is all about probabilities and while we all experience losing streaks and draw down, success as a trader is measured by how well loss trades are managed and how well trading losses are handled mentally.
One of the keys to success is the ability to pinpoint “how much one can afford to lose” at the portfolio and individual trade level. Identifying and then accepting this creates a carefree, but not careless, state of mind and the ultimate gift – freedom, which allows an active investor to execute without reservation and hesitation.
This is in stark contrast to how market losers think – “how much can I win”. This is a riskless state of mind. Trading in a riskless state creates a lack of discipline, sloppiness in preparation and impulse trading because the downside is not perceived and properly planned for. Consistency, objectivity, risk and money management also go out the door when trading in a riskless state of mind.
Thinking about losing requires discipline. By focusing acutely on how much one is prepared to risk and by documenting it in a trading plan, draw down becomes acceptable and manageable before the event occurs. This requires preparation and discipline.
As humans we are all uniquely different. Our actions in the market are influenced by our social experiences, historical biases, emotions and our beliefs about winning and losing amongst a whole stack of other goodies that will always be there because they are what make us the unique and wonderful human beings that we are. We will all therefore have different thresholds to endure drawdown. The first step is to learn what our threshold is then to determine if we can improve that threshold with respect to what we are trying to achieve in the market. This is an ongoing process that may never end……….
The first part of any risk managment program is to establish what is an acceptable loss. In planning any trade the first step nis to work out what part of trading capital is an acceptable risk amount. It is not easy but it is important to get it right.