Dealing with sucessive losses in trading
Every trader, even the best out there, have periods where every trade they touch seems to turn out being a loser. This can happen despite doing the best analysis on each potential trade. It can and does happen to every trader from time to time. These periods are known as clusters. How you deal with these clusters is what separates the best traders from the rest of the pack. I for one, have just experienced a “week from hell” in terms of trading where I have suffered several successive losses, one after the other. It is incredibly frustrating!
This is not the first time this has happened, and it certainly won’t be the last time either.
The key to trading successfully in the long term is survival, and it is during losing clusters that your long term survival as a trader is threatened most. So how do you ensure that you can stay in the game, and not let losing clusters wipe out your confidence, or worse, your capital? Here are a few lessons which I have learned over the years which have been most valuable:
(1) Risk management:
You should never risk more than 2% of your total trading capital on one trade. This means that if your trade goes wrong and you have to execute a stop loss, you won’t deplete more than 2% of your trading account. Many may think that risking 2% means you have to trade positions which are really small, and that it will therefore be difficult to really get ahead. This is not a one day game. You need to chip away at trading and make sure that your losses are small. A string of 2% losses will not wipe your capital out. When your luck turns, you will still have a healthy account balance to trade with. And your luck will turn. Just as you can have a string of losers, you can have a string of winners too, but you need to stay in the game to get the string of winners.
(2) Position sizing
This follows on from the Risk management point above. You need to ensure that your positions are of a size that they are easily manageable, and that they won’t cause you major losses when things go wrong. The way to work out your optimal position size is to decide where your stop loss is relative to your entry point, and then divide your total capital risk by that figure. For example: Assume you have a R100 000 trading account, and you buy Goldfields at R100.00 and set a stop loss at R97.00. You’re willing to risk 2% of your capital if the trade goes wrong, that’s R2000. Take R2000 and divide it by the R3.00 per share that you are risking, and that gives you your position size. In this example, you can buy 666 shares (R2000 / R3.00).
(3) Stick to stop losses
This is a non-negotiable! We have all been in positions where our stop loss is triggered, but we can’t face the prospect of taking a loss. We decide to hold on, only to watch our loss grow and grow. And as it grows, so the pain of taking the loss escalates until we either decide that the loss is simply too big to take, or we end up being squeezed out of the trade in a chaotic exhaustion move – losing a huge chunk of our trading capital. I believe that sticking to stop losses is the most important discipline in trading. Cutting losses will ensure that you are able to keep a cool head when things begin to turn nasty. I actually feel good about a trade when I execute a stop loss at the pre-determined level, only to see that the trade would have turned out a lot worse had I not cut the loss.
(4) Don’t add to losers / don’t average down
You should never add to a losing trade. If you are losing on a trade, it is clearly wrong. Why would you want to go and compound a “wrong” trade by making the position even bigger. Only ever add to winning trades, and ensure that you ratchet your stop loss up when you do so to keep the risk at a manageable level. That way your losses can be kept small and you will be in a position to remain confident even when things go wrong.
(5) Take a break to clear your head
When one experiences a string of losing trades, it is easy to get wound up and frustrated. This implies that you don’t have a clear head, and therefore will battle to think rationally and make good trading decisions. This can lead to a downward spiral which becomes self fulfilling. At this point, it is best to remove yourself from the situation completely to avoid doing further damage to your account and to your confidence. In my experience, I find that taking a week or two off after a string of bad trades allows you to clear your head and come back to the market feeling refreshed. I sometimes read a good trading book during that week to reinforce good trading habits. Don’t worry about the opportunities you may miss while you’re taking some time out. The market will still be there when you return, and there will always be opportunities to trade again.
The bottom line is that you want to remain confident and solvent as a trader. Sticking to the above guidance will help on both fronts.
By Garth Mackenzie