The market is moving with extreme volatility in recent weeks. This offers traders many opportunities to prosper and profit, but volatility is a double-edged sword. It can be your best friend one day and your worst enemy the next. Many traders love volatility when the trade is going in their favour, but struggle to deal with the downside and crumble when the pressure is on.
A trader’s first job is to survive, and in this article I hope to show you how to avoid blowing your account.
Reminiscences of a Stock Operator should be read and re-read by any aspiring trader. First published in 1923, Reminiscences is a fictionalised account of the life of the securities trader Jesse Livermore. It’s an entertaining book, and not too dissimilar from the market today. Whilst the players may change, the game often remains the same. Bucket shop tricks remain ongoing, dirty deeds continue to go unpunished, and traders still lose their cool and blow their accounts.
One quote that stuck with me from this was Jesse’s remark “And when you know what not to do in order not to lose money, you begin to learn what to do in order to win.”
Some mistakes I’ve made in my trading career:
- Buying a downtrending stock thinking I’ve picked the bottom
- Succumbing to Fear Of Missing Out and printing the top
- Getting bored and buying shares
- Averaging down again and again only to sell the lot at a whopping loss
There are of course many more. And no doubt you will have made some of these or others. My point is that, once you know not to do these things any more, you begin to stop.
Trading is a process of tilting the odds in our favour as much as possible, and by removing errors we are able to tilt the odds just that little bit extra.
Next time you see professional tennis on the TV, look at how many times the other play defeats an opponent for the point. Many times, the player will win the point due to an error by his or her opponent. Compared to amateur tennis, points are won by besting the other player all the time.
If you want to step up your trading, then find your errors and come up with a tangible strategy.
Make small mistakes
New traders will often be tempted to think of the upside. I know they will, because I did the same thing. There’s nothing like counting your profits before they’re made to teach one a good lesson. As the late Kenny Rogers said, ‘there’ll be time enough for counting… when the dealin’s done’.
Making small mistakes is the key to survival.
I hate demo accounts, and actively discourage using them for anything other than learning the buttons on the platform. Demo accounts encourage bad habits, and bad habits build bad traders. When it’s not real money, nobody is emotionally invested in the outcome. And if you’re not emotionally invested in the outcome, it’s difficult to take the task at hand seriously.
Manage psychological capital first
You can be the best trader in the world but if you don’t pull the trigger you won’t make any money. Hesitancy can be good, because it stops one piling in to a stock 200% only for the market makers to do a disappearing act with the bid and you’re left holding the baby, but hesitancy when you know you’re putting on a good risk/reward trade is costing you in terms of opportunity cost.
If you know the trade is good, as in 1) it meets your criteria for entry, 2) you are employing sensible position sizing, and 3) you know your downside and R (as we covered in my previous article), then to not take the trade is a mistake in itself.
Big losses can cause a trader to doubt themselves. Lack of faith in a system can cause a trader to doubt themselves. Overexposure to a certain stock can cause a trader to doubt themselves.
Three losing trades in a row does not a bad system make. If losing five times in a row causes you to feel uneasy, then you’re risking too much per trade. Trading is being in it to win for the long game.
It’s easy to get caught up in the next 10 trades. But you should be thinking about the next 100.
Everyone should have a get-out fail-safe in their trading system. Why? Because a lot more damage can be done to a trading account in times of heightened emotion. This is called ‘tilting’ in poker, where the player makes emotional bets rather than rational bets.
Losses are painful, and especially big ones. Taking small losses should be easy and painless, because they’re a natural cost of the business, but big losses hurt.
Having a daily, weekly, or even monthly circuit-breaker means we step away from the market and take a break to refocus and regain our composure. So far, I’ve yet to hit my circuit-breaker since I lost a large amount of money in 2017 but the dangers in trading are real and there on a daily basis.
A full time trader can go to work and lose all their money in a single day. There are very few professions where the risk of ruin is on the line day in, day out, and so having a circuit-breaker will give you the opportunity to take a time-out and cool down.
If you’re an intraday trader, then the heightened pressure only increases the potential for situations to go south. Proprietary traders have their risk limits tightened and tightened, as the best way to keep money in a fund sticky is to not lose – but you and I sat at home don’t have strict and set limits unless we set them ourselves.
It’s worth noting that these are employed not only by hedge funds but by various exchanges in an attempt to quell volatility in the market. If they’re good enough for the regulated exchanges, I’d suggest they are good enough for us too.
- Focus on surviving and staying in business – if you can do that then the profits will look after themselves
- Downside risk is priority and focus on removing errors rather than going for home run hits
- Avoid demo accounts and make small mistakes – they’re cheaper
- You need to have the confidence in your system and in yourself to execute your plan
- Employ a circuit-breaker to help prevent the risk of ruin
You can contact Michael and get your free copy of Ten Habits of Highly Profitable Traders from www.shiftingshares.com
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.